Thursday, April 5, 2012

Britons Swap Pensions For Insurance?

Mark Cobley of Financial News reports, 'Half a million' Britons swap pensions for insurance:
Over 500,000 people in the UK have now had their pension funds exchanged for guaranteed insurance policies, as a result of "pension buyout" deals worth £26bn in total. The consultancy Lane Clark & Peacock predict this will double by 2017 – as the 'takeover' of final-salary pensions by the insurance industry gathers pace.

Last year was a mixed year for these kind of deals, thanks to extreme conditions in the UK gilt markets as the eurozone crisis unfolded.

The present market value of pension liabilities, which stretch many decades ahead, are calculated by reference to the current prices and yields of long-dated UK gilts, which are some of the only tradeable securities that have similar lifespans.

When gilt prices are high, yields are low, and pension liabilities are also high. But if a pension fund is invested in gilts, or other "liability-matching" investments, then its assets will rise in tandem with its bills.

This is what happened to many schemes in 2011. The result, LCP said, was that partial buyouts, involving only retired staff, were comparatively cheap and popular last year. This is because pension funds tend to already hold portfolios of low-risk gilts to back these liabilities.

The consultancy said: "Pension plans holding gilts were able to lock in strong returns over 2011 by purchasing a pensioner buy-in. This led to a flurry of activity, with LCP completing no less than seven buy-in transactions in the final days of 2011. Conditions for pensioner buy-ins continue to be favourable in early 2012."

A total of £5.3bn worth of buyout deals were transacted last year, LCP said, mostly accounted for by pensioner-only deals. This is less than in previous years, with £8bn of deals taking place in 2008, for example. But it was an improvement on 2010.

Also last year, a few large schemes that could not afford to arrange a full pension-fund buyout opted for partial insurance cover instead, hedging their exposure to rising life expectancy.

Insurers and investment banks have begun to offer bespoke products called "longevity swaps" - these offer to pay the difference if pension-scheme members turn out to live longer than expected. £7bn of this business was done last year, mostly in a few large deals by companies including BA, Rolls-Royce and ITV.

Taken as a whole, LCP's figures illustrate the gathering shift of assets - £26bn since 2006 - from out of final-salary pension funds and into insurance companies. That is small change compared to total UK pension assets of over £900bn - but it is set to grow further.

LCP partner Richard Murphy said: "There is a huge pent-up demand for de-risking from pension plans. If funding levels improve, annual transaction volumes could hit £25bn by 2017. This should provide a real incentive for insurers to increase capacity."

Research from rival consultancy Mercer, released yesterday, illustrates the rationale behind the shift. FTSE 350 companies paid £20bn into their workplace DB schemes during the 12 months to March 31, which Adrian Hartshorn, a partner in Mercer’s financial strategy group, said he suspected may well be a record.

Despite the unprecedented payouts, the aggregate deficit in the same pension schemes actually rose by £17bn during the course of the year, Mercer said.

A common critique of the Bank of England's quantitative easing policy, which has involved artificially suppressing interest-rates and gilt yields, is that it has badly hurt pension-fund finances and made cash bailouts more likely.

But Hartshorn pointed out that actuaries already take into account expectations of future rate rises when working out pension funds' finances: "Current market expectations, implied from the gilt markets, are that interest rates will rise to about 4.5% in five years' time and stay around that level for the following decade.

"So those are the expectations we are using in today's deficit calculations, and they are not unrealistic. For things to get better [with pension fund finances] interest-rates would have to rise more quickly than the market currently expects."

Jack Jones of Professional Pensions also reports, Half a million members covered by buyouts or buy-ins:

Insurance companies are now providing benefits for more than 500,000 UK defined benefit members after a record year for buyout and buy-ins, research shows.

The fifth annual LCP Pension Buy-ins, Buy-outs and Longevity Swaps Report found £40bn worth of deals had been completed since 2006, with £12.3bn worth transacting in 2011 alone - representing a 50% year on year increase in volume.

It projected that the number of members protected by an insurance policy would continue to increase by 100,000 a year and would hit 1 million by 2017.

The consultant said demand from schemes for de-risking was even higher than the figures suggested and predicted that business volumes would accelerate rapidly if market conditions improved.

LCP partner Clive Wellsteed explained: "Pensions to members of DB pension schemes will be paid out over the next 50 years or more, but many schemes are de-risking over much shorter timescales - perhaps ten or 15 years. Insurance is the natural exit route and is fundamental to most de-risking strategies."

Fellow partner Charlie Finch said buy-ins covering pensions in payment were particularly attractive at present.

"Not only is current pricing very competitive, but the scheme and its members enjoy dual support from the insurer and their former employer," he said.

The consultant also predicted that the new Institutions for Occupational Retirement Provision directive being developed by the European Commission could accelerate demand for de-risking.

Many people fear the directive will be based on a framework similar to Solvency II which would trigger higher funding targets and necessitate increased cash contributions for DB schemes.

Wellsteed said: "As we ourselves get older, we want lower risk and volatility in our own financial affairs. The same is true here - as pension schemes reach their ‘autumn years' a clear strategy for reducing risk, including the use of insurance, will help the trustees, members and finance director to all sleep easy at night."

Indeed, most mature pension plans in the private sector are "de-risking" their portfolio, shifting assets into fixed income and accepting "pension buyouts" from insurance companies.

I'm a little leery of these so-called pension swaps. Insurance companies aren't doing this to lose money. They obviously think they can make a bundle on such deals or else they wouldn't be aggressively marketing this 'natural exit route' to companies struggling to fund their DB plans.

This all reinforces my idea that private companies shouldn't be managing DB plans. If the best they can do for their members is swap into some insurance policy paying a low fixed rate, then the members lose and the tend toward pension poverty will continue. Instead, they should be enjoying the same pension perks as public sector workers and elected officials, all of whom have gold-plated defined-benefit pensions.

But this wolf market dominated by big banks, huge hedge funds and high-frequency trading platforms are scaring investors and pensions away, forcing many companies to 'de-risk' at the worst possible time. Meanwhile, public sector pension funds are cranking up the risk but most of them are going about it the wrong way, plowing billions in alternatives, getting raped on fees.

By the way, the bears are growling on Wall Street, warning everyone another crash is imminent. It seems everyone on Wall Street wants more 'stimulus' (drugs) from Dr. Bernanke and his colleagues. And now Euro debt fears resurface over Spain.

I think everyone needs to take a 'chill pill' and realize we just came off one of the strongest first quarters in years. A pullback is normal. I remain bullish on stocks and think this pullback is just another buying opportunity. A rotation into materials is imminent once fear dissipates.

Once again, investors fearing the worst is yet to come will be chasing risk assets at much higher levels in the second half of the year. There is a reason why the Fed isn't providing more stimulus at this juncture and it's not because they fear the sky is falling.

Below, Canaccord Genuity's Tony Dwyer and Bloomberg's Adam Johnson talks about the outlook for U.S. stocks. They speak on Bloomberg Television's "Street Smart." Mr. Dwyer is extremely bullish, emphasizing various technical indicators. I'm not a huge fan of the so-called 'Golden Cross' but just think that there is ample liquidity to drive risk assets much higher. As the US recovery takes hold, many sitting on the sidelines will be forced in at higher prices.