Thirty years in the making.
2017 marks Legal & General's 30th year in the bulk annuity market. Ashu Bhargava reflects on some of the key changes in the industry over the past three decades.
1987 was an eventful year. A cartoon called The Simpsons first aired on the Tracey Ullman show, October saw the 'Black Monday' stock market crash and in the same month, weather forecaster Michael Fish famously reassured the nation: "Earlier on today, apparently, a woman rang the BBC and said she heard there was a hurricane on the way... well, if you're watching, don't worry, there isn't!". 1987 was also Legal & General's first year of operation in the bulk annuity market.
Today more than £80bn of defined benefit (DB) pension obligations have transferred from company balance sheets to insurance companies and millions of members' pension benefits have been secured with insurance companies in this way. Bulk annuities have evolved from a specialist product that pension schemes used infrequently into the endgame destination for many schemes today. The insurance industry has supported more than £10bn of buy-ins and buyouts annually over recent years.
How did we get here?
The answer lies in the journey that pension schemes and companies have been on over the past 30 years. If you worked for a company in the UK in 1987, you would have most likely received a pension linked to your final salary. Your scheme would likely have been open to new members, invested predominantly in growth assets, such as equities, and would have undertaken little or no hedging of risks.
For many companies at the time, it's unlikely that their pension schemes would have been seen internally as anything more than a standard employee benefit, a view underpinned by long term confidence that assets would outperform liabilities, and prior to medical advancements which have contributed to improving life expectancies.
Chart 1: Long-dated gilt yields
Source: Bank of England
Chart 2: Life expectancy at age 65 (in years), UK
Source: Office for National Statistics
In this world, insurance companies, like Legal & General, played a specialist role where they would secure what benefits they could with scheme assets when a sponsoring company went under. Given that corporate bankruptcies are relatively infrequent events, the UK pension buyout market remained small at around £1-2bn annually.
A sea change
In 2004, the buyout market was set for a shake up with the inception of the Pension Protection Fund (PPF). Since insolvent sponsors typically have underfunded pensions, the expectation was that the PPF would replace the insolvent buyout market. At around the same time, the cumulative impact of pension regulations, accounting rules, declining interest rates and increasing longevity, led to a view that DB pensions had become too onerous for their sponsors.
Buyouts previously reserved for insolvent sponsors, now offered solvent companies the chance to honour their pension commitments whilst transferring a burdensome obligation to a professional third party, thereby freeing companies up to focus on their core businesses. A market in which all DB pension schemes were potential clients led to the entry of more insurance providers, competitive pricing and innovation, all of which have helped to drive the market forward.
The new era of harder regulation and mature, de-risked schemes which are closed to accrual, has seen insurance companies become the second consolidator in the industry and the final resting place for many of the UK's DB pension promises.
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We are authorised by Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Legal & General Assurance Society Limited. Registered in England and Wales No. 166055. Registered Office: One Coleman Street London EC2R 5AA.
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