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Navigating choppy waters: DB pension scheme de-risking

Few parts of our society have been left untouched by the ongoing Covid-19 pandemic: it’s swept over our healthcare system, economy and personal lives with unprecedented force.

The £1.9 trillion UK Defined Benefit (DB) pensions landscape offers no exception[1]. In the current environment, many companies that sponsor DB pension schemes are considering suspending their deficit repair contributions (DRCs) to shore up their own finances. 

However, their role in providing income and security in retirement to 10.1 million people across the UK is as important as ever, and the need for personal financial security has become even greater[2]. Nearly one in four adults say that the coronavirus is affecting their household finances, with 73% citing reduced income as their primary concern[3]

Recent market volatility coupled with the weakening of sponsor covenants will no doubt strengthen many trustees’ resolve to find a safer and more certain path ahead to secure and protect their members’ benefits. For their corporate counterparts any return to falling and unpredictable pension scheme funding levels will similarly be an unwelcome challenge to add to a growing pile of competing priorities. 

The bulk annuity market
The good news is that the safe harbour most aspire to – a buy-in or buyout with a UK insurer – remains open, with insurers continuing to focus on bringing their expertise and risk capital to those pension schemes that remain in choppy waters. 

The Covid-19 pandemic has disrupted the bulk annuity market like any other industry. First and foremost, insurers have been focused on supporting their customers during this time by ensuring that pensioners and trustees get paid promptly, and that service levels are maintained. 

At the same time, the ongoing market volatility has created pricing opportunities for those well prepared and willing to move decisively. The lower cost of high-quality corporate bonds – which underlie insurer bulk annuity pricing – has led to a step improvement in pricing, with those pension schemes with a high proportion of their assets held as gilts benefitting most. 

Appetite from both sides of the table to complete further transactions therefore hasn’t diminished. Recent predictions put expected bulk annuity market volumes for the year at £25 billion, which would make 2020 the second most successful year in the market’s history[4]. Current momentum remains strong, with Legal & General announcing eight transactions in March alone.
 

Insurance led innovation
For the many trustees that have charted a course to full pension scheme buyout, recent events have shown that periods of smooth sailing towards that destination can quickly become disrupted by volatile investment markets and unforeseen events. By leveraging their existing investment and insurance toolkit in new ways, insurers are also playing a leading role in facilitating a smoother and more predictable journey for trustees. 

One such example of innovation is an Assured Payment Policy (APP), which allows a pension scheme to lock down investment risk by providing protection against changes in asset yields as well as interest and inflation rates (including inflation linkage for pension increases that may be difficult to otherwise accurately hedge). APPs allow a pension scheme to be more selective in the choice and timing of the risks to insure along its journey.

The AIB Group UK Pension Scheme and Legal & General concluded the first APP at the end of last year as part of a larger £1.1 billion risk transfer transaction. 

Insured Self-Sufficiency (ISS) is another new solution that can be accessed at an earlier stage of a pension scheme’s de-risking journey. ISS brings together the expertise of both Legal & General’s investment management and insurance businesses, providing trustees with the capital and investment capabilities they need to run their pension scheme like an insurer. This allows de-risking plans to be accelerated at a more affordable pricing level than bulk annuities, whilst providing many of the same benefits.
 

Looking ahead
The strength of the UK insurance regime will once again be tested during this pandemic, but robust capital provision and strong regulatory oversight mean that UK insurers continue to deliver real security for their policyholders. 

No doubt trustees and their corporate sponsors will now have renewed focus on ensuring that the transition to buyout happens in as safe and orderly a fashion as possible. UK insurers are rising to the challenge of supporting this process with innovative solutions which bring much needed stability in an uncertain world.

For further information please contact derisking@landg.com

[1] PPF (2020), The DB landscape: Defined benefit pensions 2019
[2] PPF (2020), The Purple Book 2019  
[3] ONS (2020), Coronavirus and the social impacts on Great Britain: 16 April 2020  
[4] LCP (2020),  LCP expects buy-in/out market volumes in 2020 to be second largest on record

Frankie Borrell

Article written by:

Frankie Borrell

Head of Client Solutions