LCP’s research shows that the average DB scheme has seen a 15% improvement in funding over the past year relative to the cost of transferring to an insurer, also known as the “buy-out cost”. Nearly 1 in 5 of the c5,000 DB schemes in the UK are now estimated to be fully funded against the buy-out cost. The average projected period to reach full funding on buy-out has reduced by over 5 years as schemes have made a huge leap forward over the past year.
The total aggregate buy-out cost has tumbled by close to £1,000 billion from £2,300 billion to £1,400 billion over the year to 30 September 2022. To put that in context, the reduction in pension liabilities of close to £1,000 billion equates to nearly half of the UK’s annual GDP.
LCP’s analysis predicts that, as a result, there could be over £200bn of liabilities transferred to insurers over the next three years in a market that has seen around £30bn transferred in each of the past two years. This unprecedented wave of demand reflects a concentration of schemes that were previously projected to reach full buy-out funding in the late 2020s now being able to move to insurance much sooner.
The main driver in the acceleration in funding has been the rapid rise in long-term yields, which insurers use to determine the buy-out cost. This rise accelerated sharply in the wake of the “mini-budget” on 23 September 2022 and, even in current slightly calmer markets, yields remain higher than they were over a decade ago. Insurer pricing has also been helped by further evidence that life expectancies are stalling and by strong competition amongst the eight insurers in the market.
LCP is warning that the insurance market faces a huge challenge to deal with this unprecedented wave of demand from schemes over the next few years. Data from the insurers indicates current annual capacity of £45bn. With projected demand of up to £60bn next year, a potential “capacity gap” could open up in 2023. This could lead to constraints, particularly operationally, but the insurers do have the ability to flex capacity to an extent and the largest transactions are increasingly being treated like one-off M&A opportunities rather than as part of an insurer’s normal annual capacity.
Charlie Finch, Partner at LCP, commented: “The economic upheaval of the last few weeks has led to a staggering change in the financial position of pension schemes. The combined cost of transferring Britain’s defined benefit pension schemes to an insurance company has fallen by close to an astonishing £1 trillion in the past year – an amount equal to nearly half the size of the UK economy being wiped off company pension obligations. We expect this to trigger an unprecedented wave of transactions between defined benefit schemes and insurers as UK plc seeks to shed their legacy pension liabilities.
“But the skyrocketing demand for pension buy-outs is likely to run up against market capacity buffers. The industry simply does not have the operational bandwidth to process the potential number of schemes moving to insurers. Once schemes have navigated the recent market turmoil they should re-assess their strategy. Many schemes had planned for a journey lasting five years or more to reach buy-out and will now be finding that recent events have significantly truncated that timeline.”
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