Best buy-out conditions for a decade – LCP

Stalling life expectancy has created the best conditions for DB buy-outs for a decade says LCP.

A report from the consultancy published today argues that lower projected life expectancies have created the best opportunity for companies to transfer defined benefit pension schemes to an insurer since the banking crisis in 2008.

The report shows one in five FTSE100 UK defined benefit pension schemes are now estimated to be over 80 per cent funded relative to the cost of buy-out with an insurer, up from one in eight a year ago. LCP’s analysis shows that average buy-out funding has increased by nearly 10 per cent since the immediate aftermath of the EU Referendum in August 2016 to reach the highest level since the banking crisis in 2008.

The improved affordability has been driven in large part by recent heavier-than-expected mortality data says LCP. New data published in 2017 resulted in lower projected life expectancies, with the life expectancy of a 65 year old man falling by nearly half a year. On average, this new data has reduced pension scheme liability values by around 3 per cent.

LCP expects a 50 per cent increase in volumes of UK pension liabilities being insured in 2018 as pension schemes take steps to reduce risk. The consultancy argues this new higher level of buy-outs will become normal, with annual volumes increasing to over £15bn.

Insurer back-book transactions are likely to provide competition for capacity, with providers such as Prudential currently considering options for transferring part of its annuity fund to other insurers.

In response to the anticipated rise in demand, incumbent insurers are increasing their capacity. LCP estimates total insurer capacity for 2018, across buy-ins, buy-outs and annuity back-books at around £25bn, 35bn higher than last year.

LCP partner Charlie Finch, who wrote the report, says: “Companies looking to reduce pensions risk are finding the best financial conditions to do so since the banking crisis. Prompt action will allow them to benefit from the current high-level of competition between insurers.

“The improvements in affordability mean that many pension schemes can currently reduce risk through insurance. Some finance directors will conclude that now is the time to write the cheque and transfer the scheme in full to an insurer. Even where that remains unaffordable a partial transfer to an insurer through a buy-in is usually achievable at no cash cost.

“Improving affordability is down to three primary factors: buoyant investment markets, insurers improving their ability to source attractive long-dated assets that are effective under the new Solvency II regime, and a convergence in views that pensioner life expectancies are reducing, on the back of several years of heavier-than-expected mortality rates.”