De bunking-derisking myths

2014 is shaping up to be a record-breaking year for pension schemes transferring risks to the insurance market via bulk annuities (buy-ins and buy-outs) and longevity swaps.  With over £10bn of deals already completed, the question is no longer whether 2014 will be a record-breaker but by how much?  Based on our work and experience we predict that total volumes of de-risking transactions could exceed £30bn by the end of 2014.

Interest in de-risking transactions is high but there also a lot of misconceptions in the market. At our recent Pensions Forum, attended by over 30 invitees from leading UK pension schemes, we aimed to de-bunk some of the myths surrounding buy-ins, buy-outs and longevity swaps.  

 The top 10 myths we de-bunked are: 

 1.    “Pensioner buy-ins are always the best step towards a full scheme buy-out”

False - In recent years the mantra of ‘swap gilts for annuities’ in the right economic conditions has led to increased interest in buy-ins for pensioners in payment.  Whilst a pensioner buy-in can be a suitable investment opportunity for many schemes, it may not be the best strategy for schemes within five years of full buyout. At this stage, schemes may find that the total price when buying-out the remaining deferred pensioners at a later date is more expensive than waiting to buy-out the whole scheme in one transaction. In 2013 we helped one client buy-out their whole pension scheme ahead of schedule after holding off on a pensioner buy-in the previous year.

 2.     “Full buy-out is too expensive for my scheme”

False - We see a number of cases where affordability has been assessed on prudent Scheme Actuary buy-out estimates. On a number of our transactions completed in the last year, looking at a more realistic market pricing and allowing for savings arising from member options and Winding-Up Lump Sums has brought buy-out into view some two to three years earlier than anticipated.   Using our real-time valuation software, Skyval, our clients have been able to monitor realistic buy-out affordability on a daily basis. 

3.     Size matters – “I’m too big for a buy-in”

False - 2014 has already seen a £5bn longevity swap and a £3.6bn pensioner buy-in. The market is now ready to take individual deals of up to £10bn. There are very few UK schemes which can claim they are now ‘too big to insure in one transaction’.

 4.     “Medical underwriting is only for small scheme buy-ins”

False - To date, all medically underwritten bulk annuities have been less than £50m. But larger schemes should also consider this option where, for example:

  • Buy-out is not an immediate prospect but members with the highest pensions today could be secured with a medically underwritten buy-in policy. 
  • Individual large liabilities can be insured via a medically underwritten policy, reducing the idiosyncratic risk in the scheme. 

5.     “Buy-outs are only for closed schemes”

False - We have worked with clients who have agreed mechanisms to continue accrual after a buy-out.  The ongoing accrual costs are paid across to the buy-out insurer in regular instalments.

 6.     “The buy-in/buy-out marketplace is less competitive than it used to be”

False - Although there have been more insurer exits than entrants over the last two years, the market is now more competitive than ever. Following the Chancellor’s 2014 budget, insurers have seen falling sales in the individual annuity market, and those who provide both individual and bulk annuities are now applying more focus to their bulk annuity offering.  In particular, we are seeing insurers who previously only quoted on deals up to £50m now increasing that limit to deals up to £200m. This provides greater price competition at these deal sizes and will also have a positive knock-on effect on pricing for larger deals.

 7.     Longevity capacity – “Longevity capacity will run out due to a lack of alternatives”

False – We predict that 2014 will see the first longevity swap between a pension scheme and the reinsurance market using a captive insurance entity owned by the pension scheme. Once the first deal of this kind has been completed, we would expect more schemes to follow suit using this cost efficient option. This increase in longevity risk transfer will raise the question of how much capacity the reinsurance market can take. Our discussions with reinsurers suggest that the capacity for transferring UK longevity risk remains strong for the short to medium term although the issue for pension schemes is the low operational capacity in reinsurers’ teams. Schemes need to present their quote requests in the best possible light to ensure that their quote is next on the list for the very busy reinsurance team.

 8.     “Longevity swaps are bad for your figure”

False - Historically, schemes looking at longevity hedging would have seen an impact on the trustee funding position and the company accounting balance sheet.

  • We have seen longevity hedging quotes come in with no impact on technical provisions. This is especially true in today’s world where many schemes are considering the use of a ‘do-it-yourself’ captive insurer to access the reinsurance market.
  • Changes in accounting regulations mean that longevity swaps can come onto a sponsoring employer’s balance sheet with nil impact.

 9.     Size matters – “I’m too small for a longevity swap”

False - Pension scheme longevity swap contracts have traditionally been over £1bn each due to both price efficiency and provider appetite. But the use of captive structures has increased the options for smaller deal sizes with direct access to reinsurer pricing which does not vary significantly with deal size.  In one current case we have received attractive, transactable pricing from the reinsurance market for a £100m deal.

 10.  “I am ready to react to market opportunities”

False - If you ask a pension scheme if they’re ready for longevity swap and bulk annuity transactions most will say “Yes”. The reality is that although many pension schemes are run well for day-to-day business, a risk transaction will require additional data cleaning and a review of historic scheme documentation which if not ready can severely hold up the process. Schemes should have their data prepared in advance so that they can act quickly when a market opportunity arises.  Both trustees and sponsoring employers should ensure governance is in place to monitor and identify market opportunities – our Skyval platform allows all parties to track this common information on a real-time basis.



Ben Stone  | Senior Manager
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