In this busy environment LCP is urging schemes that wish to transact to get their homework done so they are transaction ready and fully prepared before they enter the market, so as to maximise their chances of achieving attractive pricing and terms.
LCP has five predictions for the market in the year ahead:
1. Buy-in/out volumes will be the highest on record breaking the £44 billion record set in 2019
LCP anticipates buy-in and buy-out volumes will exceed the record £43.8bn achieved in 2019. This is despite gilt yields being much higher today than in 2019, thus reducing the size of schemes and transactions. This prediction reflects high demand for buy-ins and buy-outs following an average c15% improvement in the buy-out funding positions of DB schemes over 2022. On average DB schemes leapt over 5 years ahead in their journey to full buy-in/out.
A busy market means that schemes will need to work doubly hard to get ready and ensure that insurers will want to participate in quoting for their scheme.
2. Pricing will continue to be attractive for schemes preparing properly
Pricing improved significantly over 2022 and is currently at historically attractive levels for both pensioner and deferred pensioners. For those schemes that have properly prepared and positioned themselves attractively to insurers, LCP believes similarly attractive pricing will remain available in 2023 if current market conditions continue, but schemes will have to work much harder than in the past to secure active insurer participation.
3. There will be fewer partial buy-ins, more full buy-ins and some longevity swaps
Schemes are now operating with higher collateral levels post the ‘LDI crisis’ to improve resilience to future gilt yield rises. This means there is less capacity to undertake partial buy-ins at an early stage in a scheme’s journey. For larger schemes, this may tilt the balance from using buy-ins to using longevity swaps to hedge longevity risk, but care needs to be taken as longevity swaps themselves typically require collateral (eg if life expectancies fall in future).
That said, many schemes have seen their funding improve and so need less return-seeking assets. This itself creates more capacity to undertake partial buy-ins, but if schemes are close to being fully funded they may prefer a strategy to move straight to full insurance.
4. New innovation to help address the illiquid asset challenges for schemes
An increasingly common barrier to full insurance is the illiquid assets that are held by some schemes. This has been exacerbated by the LDI crisis with illiquid asset allocations growing in percentage terms as schemes shrunk in size. LCP predicts that new innovation will appear to address this illiquid challenge including better ability to transfer illiquids to insurers alongside innovative deferred premium structures and other disposal options that better preserve value.
5. The chance of a new entrant entering the buy-in/out market is the highest for some years
Investors and other parties have long been interested in establishing a direct presence in the bulk annuity market but there has not been a new entrant since Phoenix Life (now Standard Life) in 2017.
LCP predict that 2023 has the highest chance that a new entrant emerges for some years given the changing supply and demand dynamics in the market. If so, LCP expects that it is most likely to be an existing insurer because of the high barriers to entry. Even for an existing insurer there will be a considerable lead-in time as they recruit and develop capabilities.
Commenting on LCP’s predictions for 2023, Charlie Finch, Partner in LCP’s de-risking practice, said: “2022 was a roller-coaster year but the average DB pension scheme starts 2023 in much better shape than a year ago. The record improvement in average buy-out funding levels is likely to lead to record de-risking activity in 2023 surpassing the £43.8bn of buy-ins and buy-outs in 2019. Alongside more transaction volumes, we expect to see a further increase in the number of large schemes using buy-ins and buy-outs rather than self-sufficiency.”
Catherine Hopper, Partner in LCP’s de-risking practice, added: “The good news brings with it a fresh challenge of deciding when, if and how to approach insurers, particularly as many DB pension schemes had not planned to be in a position to buy-in so soon. Schemes wishing to transact will need to ensure they have done their homework properly ahead of approaching the market and have prepared in an optimal way. This will be a key factor when insurers choose which transaction opportunities to prioritise with their best pricing and terms.”
Charlie Finch, concluded: “Insurers have shown a remarkable ability to innovate and develop new solutions. This will be important as we enter a new phase of the market over 2023.”
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