The Book reports that for the 5,945 schemes covered, the “full buy-out” liability is now £2.1 trillion, which represents a 24% increase from £1.7 trillion last year and is the highest aggregate figure on record since the Book was first published in 2006.
While some of this increase is down to benefit accrual and liability interest over the last year, the majority is as a result of significant reductions in gilt yields over the period, with falls in nominal yields of over 120 basis points at the long end of the gilt yield curve in the year to 31 March 2015. Asset values only increased by 14% over the same time period (from £1.1 trillion to £1.3 trillion), despite a year’s worth of recovery contributions, meaning the aggregate buy-out deficit increased by more than £200 billion in the last year alone.
The Book also shows that over the last 10 years schemes have taken significant de-risking steps:
On the liability side, the percentage of open schemes fell from 43% in 2006 to 13% in 2015 and those closed to accrual increased from 12% to 34%. While this does not necessarily solve the deficit problem, it can stop it getting worse.
On the asset side, between 2006 and 2015, the equity share of assets held by schemes fell from 61% to 33% and gilt and fixed interest share rose from 28% to 48%. This shows a clear trend to asset de-risking, making longevity the increasingly dominant risk remaining for many schemes.
Looking at the increase in deficit figures alone may suggest that, despite some de-risking activity being undertaken by schemes, the end game objective of buy-out may have moved further away for many schemes.
Emma Watkins, Director of Bulk Annuities at Scottish Widows said “Schemes may look at these figures and assume that buy-in or buy-out is now out of reach. This is not necessarily the case. These are point in time aggregate estimates, but the affordability for any particular scheme depends on a number of factors: their individual funding level, the assets they are holding to back their liabilities, daily changes in market conditions, and supply side factors in the insurance market.
“For instance, an insurer may have a particular investment opportunity that can improve the pricing they can offer, which cannot be captured in these figures. Indeed, over the course of 2015, many schemes completed pensioner buy-ins at a pricing level similar to an equivalent valuation on a gilt basis. For those serious about de-risking, schemes can only know the true cost of insurance by approaching the market and then being ready to transact when an opportunity arises.”
The Book reports that the value of risk transfer deals – buy-outs, buy-ins and longevity swaps - since 2007 to June 2015 sums up to £105 billion with just under half of these deals being longevity swaps. Recent figures published by LCP show that the market for buy-ins and buy-outs this year is over £10bn, down on 2014’s record £13bn. However, based on the figures in the Book only 0.5% of total buy-out liabilities have been insured this year. The insurance market clearly has the potential to grow materially. While news about the impact of Solvency II is mixed, the consensus view from other market commentators appears to be that pensioner buy-in pricing will be broadly unchanged and non-pensioner pricing is likely to increase slightly.
Furthermore, with eight insurers actively writing business, noting Scottish Widows’ entry into market in 2015, supply has increased. Indeed, LCP predicts that insurer capacity for 2016 will be over £15 billion, an increase of £5 billion on 2015. Overall, this means that schemes should expect greater competition in 2016, which some could argue will improve pricing.
Watkins added, “We expect 2016 to be a very busy year in the market for buy-ins and buy-outs. The processes for risk transfer to insurers have become more efficient due to experience gained in recent years and so the market could cope with an increase in demand. As such, we expect a significant number of schemes to achieve their de-risking goals in 2016.”
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