Can the market cope with the expected levels of demand?
There is around £1.3 trillion[1] of defined benefit liabilities in the UK. Only around 15%[2] of those liabilities have been insured via bulk annuities to date, despite the record volumes in 2023. With lots of schemes expected to reach their long-term funding goal in the coming years, we are anticipating a further uptick in demand, notwithstanding the potential Mansion House reforms which will influence the desired endgame for some. A conservative estimate would be a further £500bn of bulk annuity transactions over the next five to ten years.
So can the market cope with this? Well the good news is that capital is not a constraint. The insurers were anticipating higher volumes, in monetary terms, in their business plans, and they sourced capital accordingly. That, coupled with the high interest rate environment, means that the insurers have lots of spare capital ready to deploy. As of 31 December 2022, the nine bulk annuity insurers collectively held nearly £30bn[3] of excess capital over and above their solvency capital requirements. Some of that was in anticipation of a stellar 2023, and it will have been used to write new business, but we still anticipate significant headroom when the insurers release their 2023 year-end positions. The Government’s proposed reforms to the regulatory regime (in the form of Solvency UK) may release further capital to write new business. Over the medium term, the existing insurers have the support of their investors to continue to grow their businesses, and most of their backbooks are now of sufficient size that they are generating surplus capital each year that can be used to write more new business.
As Sarah highlighted, 2023 saw a new entrant in the shape of M&G and we expect a scaling up of their appetite over the coming years. There are others looking closely at entering the market too, all of which will provide additional capacity in the coming years.
The real constraint for the insurers is people. Each transaction needs to be priced, often by multiple insurers, transacted and then onboarded, with each stage requiring specific expertise. The pricing stage in particular can be very resource intensive, similar to a pension scheme’s first funding valuation, but with the added pressure to complete it within a six-to-ten-week window. The insurers are looking to meet this challenge by scaling up their teams, but there is a limited pool of experienced individuals to recruit from, and their efforts to train new colleagues will take time to bear fruit.
There are also pressures on the adviser side, particularly at administrators. On top of their business-as-usual work, a bulk annuity transaction often requires administrators to complete significant amounts of data cleansing and to provide additional data extracts that meet the insurers’ requirements. They are also currently grappling with GMP equalisation and the requirements of the pensions dashboard programme. From a transaction perspective, it is vital to secure resource ahead of time and to focus the administrator’s efforts on tasks that really matter.
Market intelligence tells us that there was capacity for over £60 billion of bulk annuity transactions last year. So, despite the surge in demand, there was still capacity for more than the c.£50 billion that was written. It is reassuring that current constraints have not yet got to the stage where schemes are unable to transact. However, should demand continue to increase, that could become the case, particularly for smaller schemes. In practice, we think this is highly unlikely as we expect insurers – both current and prospective – to react to take advantage of a highly attractive business opportunity in a thriving market.
How should pension schemes react to best position themselves in the market?
The insurers all reviewed their strategic priorities over 2023 and specifically the profile of transactions that they choose to quote on. The level of demand has allowed them to be far more selective and prioritise cases where they think they have the best chance of winning and where they perceive there to be a smoother path towards execution. This latter point encompasses both the level of preparatory work undertaken by the trustees, and also the design of the quotation process.
The former point – that insurers are only quoting on deals where they perceive they have the best chance of winning – sometimes causes initial concern from our clients that they may not get the best possible pricing. In fact, what’s happening is the insurers are just ruling themselves out of processes where they know they won’t be able to offer attractive pricing – for example if they know that their pricing for heavily pensioner portfolios has been less attractive in recent months. This means that the quotation process can be more focussed on those insurers who are likely to offer the best price from an earlier point.
You may hear about the insurers’ ‘triaging’ processes. In other words, the insurers working through the requests that land in their inbox each week and identifying which cases to quote on considering their strategic priorities and resource constraints. It is important for trustees to understand what drives those decisions and, where they can, remove any barriers to an insurer’s participation. We recently held research sessions with all of the insurers to discuss their triaging processes at length. The key themes from those discussions are summarised in our top tips to demonstrate transaction readiness.
