UK pension schemes are increasing the rate at which they strike deals to transfer risk to an insurance company.
The combined value of buy-outs, whereby an entire scheme is passed to a specialist insurer, and buy-ins, which involve buying a policy to cover the liabilities of a particular group of scheme members, reached £5.2bn ($8.4bn) in 2010, compared to £3.7bn a year earlier, according to a report by Hymans Robertson, a consultant.“An increase in mergers and acquisitions activity is driving this,” said James Mullins, head of buy-out solutions at Hymans Robertson. “Any potential purchaser will welcome a company that has already done a deal to transfer risk to an insurer. There is less to worry about.”
An increasing number of closures and part-closures of defined benefit pension schemes and concerns over longevity risk was also contributing to the trend, he said.
Buy-ins proved to be most popular with pension scheme trustees. Unlike buy-outs they do not require a large cash injection from a scheme sponsor and are often the first step towards a full buy-out. “Many companies would like to do a buy-out but cannot yet afford one,” said Mr Mullins.
Overall deals, including longevity swaps, rose to £8.2bn for 2010, a little above the £7.9bn seen in 2009 and £8bn in 2008.
Mr Mullins expected volumes to rise still further this year as several large buy-ins and longevity swaps are due to be completed. He forecast a rise to £10bn-£15bn, with a quarter of FTSE 100 companies likely to have completed a pensions scheme transfer deal by the end of 2012.
GlaxoSmithKline became the tenth FTSE 100 company to complete a deal in December when it arranged an £892m buy-in with Prudential. Rothesay Life, the insurance arm of Goldman Sachs, took the lion’s share of the buy-in/buy-out market in value terms last year, accounting for a quarter of activity.
Donia O'Loughlin of the FT Advisor also reported on the rising demand from pension schemes to transfer risk:
A new report from pensions and benefits experts Hymans Robertson has predicted that around £20bn of pensions liabilities could be transfered to banks and insurance companies in the next 18 months, taking the total value of this market to £50bn.
The paper, Managing Pension Scheme Risk Report Q4 2010, found that insurance companies and banks have already taken on the risks associated with around £30bn of pension scheme liabilities since the transfer market took off in 2006/2007.
The pensions and benefits experts attributed the increase to banks and insurers taking increased control of defined benefit (DB) scheme risks.
Hymans claimed that members of defined benefit (DB) pension schemes will increasingly be relying on insurance companies and banks to provide their pensions.
Last year saw a record £8.2bn of risk transfer deals, with buy-ins and buy-outs covering around £5.2bn of pension scheme liabilities and longevity swaps covering around £3bn, according to the report.
The value of buy-ins was more than five times the value of buy-outs during 2010, highlighting their increasing popularity.
Given the ever increasing demand from pension schemes to transfer their risks, it would be no surprise to see new entrants to this market during 2011, claimed Hymans.
It expects one in four FTSE 100 companies to complete a material pension scheme risk transfer deal before the end of 2012
James Mullins, head of buy-out solutions at Hymans Robertson, said: "Banks and insurers continue to offer new flexibility to make risk transfers accessible to all pension schemes.
"It is crucial that companies and trustees are aware of this flexibility and innovation to ensure that they do not miss excellent opportunities to reduce risk. In addition, schemes are increasingly keen to manage away as much risk as they can.
"There is a snowball effect here: the more schemes that tackle risk, the more pressure there is on others to follow suit.
"The raft of final salary closures over the last two years and the impending restrictions on tax relief for high earners' pension contributions, are also increasing the demand from schemes to reduce risk."
It's clear that the pickup in M&A activity is what's driving the trend for private companies to transfer over their pension risk to insurance companies. Don't worry, I'm sure banks and insurance companies are more than happy to take on this risk and make a nice profit in the process.
Finally, over in the public sector, the FT reports that state workers to pay more on pensions:
Public sector workers, such as teachers, health workers and police officers, would see their annual contribution rates to pension plans rise even more than the £2.8bn increase sought over the next three years, under plans laid out by George Osborne, the chancellor.
The issue revolves around a technical matter, known as the discount rate, which is used to calculate the cost of earning each additional rate of pension benefits for many years in retirement.
Discount rates are intended to take account of the time value of money many years into the future. The lower the discount rate, the higher the future value of a pension income becomes.
However, the chancellor said the government does not intend to seek further contribution rises. Instead, it will accept proposals set out in a review of public sector pensions conducted by Lord Hutton, the former Labour minister, that will slow the rate at which new benefits are earned and raise retirement ages.
Local authorities and public sector unions have warned that the contribution increases being sought are likely to prompt thousands of workers to opt out of pension provision.
The new discount rate would be 3 per cent over inflation as measured by the consumer price index.
Until now, the rate has been 3.5 per cent above the retail price index. Using the Office for Budget Responsibility’s forecast of the gap between the two, estimated at 0.83 percentage points, the effect is a cutting of the discount rate by 1.3 per cent.
“Today we publish the result of our consultation on the discount rate, which shows that a more appropriate rate would be inflation plus GDP growth,” the chancellor said.
“This reinforces our case for increasing the employee contributions by an average of 3 percentage points. Indeed, the new discount rate could be used to justify further contribution rises.”
To sum up, in the private sector pension risk is being transferred and in the public sector they're cutting the discount rate to increase contribution rates. As I've stated before, the global pension squeeze is on and policymakers are taking note of what's going on in the UK because in all likelihood, similar measures will be taken throughout the developed world. In the new era of austerity, workers will have to deal with the harsh reality of broken pension promises.