In a long and well -informed “big read”, the FT has published its thoughts on the structural shift in DB pension provision known as bulk buy-out.
The article begins with the memories of 71 year old John Shaw and the relief he fealt in 2021 when his benefits (part of the Metalbox pension) were bought out by PIC.
The article ends with an ominous quote from the CEO of Phoenix, Andy Briggs
“I’ve never met the finance director of a company in any sector that has a large defined benefit pension scheme attached to their core business that is pleased to have it, as soon as they can afford to buyout, most would move to [do so].”
The bookending is significant. It is generally thought that buy-out is that most dangerous of phenomena , the “win-win”. Members get benefits secured above the PPF minimum while employers remove unwanted risk from their balance sheet,
Perhaps that is why the Trustees of the BP Pension Scheme let it be known to the FT that they were in an “advanced state” of negotiation to swap up to £30bn of assets for an insurance policy that would pay member pensions when they came due.
But that announcement has sparked considerable debate. On Saturday I published a blog questioning who would be the win-winners which attracted considerable comment on linked in
Many people seem to share my view that the current debate is not as even-handed as that in the FT “Big Read”. Maybe BP will find that its membership are not as relieved as John Shaw, BP’s balance sheet is strong and so is its P&L – it is no Metalbox.
An more even handed view?
The FT’s reporting on this subject has been excellent. It is reporting at a crucial juncture of the debate and I am doing no more than amplifying what is written by them and said by senior sources.
At a high level (and pensions are centre stage in tonight’s Mansion House Speech from Jeremy Hunt, transferring an estimated £600bn from occupational trustees to insurers over the next ten years, will make a profound shift in who holds the nation’s liquid assets.
Hunt told the FT that he was not calling for a major change in DB investment , arguing that they prop up Government debt. They are indeed the largest holders of long dated and inflation linked debt (the latter by some way). Hunt argues that more of DC workplace pensions should be invested for growth. This suggests he sees the DB sector as in gilt- lockdown.
The insurers would argue differently. As we will see later, money transferring to buy-out is not transferring to gilts. Indeed insurer’s backing assets look nothing like the assets backing corporate DB schemes (and nothing like gilts).
Because of this non-alignment of assets, there is likely to be considerable buying and selling of assets as schemes prepare for buy-out. This has consequences.
For instance. the FT finds that in lining schemes up for the insurers , DB pension schemes are gong to have to make some substantial changes in the way they invest and the assets they hold. The holding of private credit is one example, it forms the bulk of the illiquids held by private sector DB schemes and it doesn’t look the kind of asset an insurer would want to hold. The FT tells us
…schemes’ exposure to illiquid assets varies from 10 to 30 per cent. Many originally invested in them to help get scheme funding to the point where a buyout is feasible. One insurance executive says pension schemes are telling him it will take “two or three years” to exit such positions and some may need to shoulder a loss on disposal of up to a fifth.
Much of this private credit is recently purchased. It would seem , that just as DB schemes were caught short when gilt yields blew up their LDI portfolios, they are caught short again as they rush to accelerate their “DB endgame” from a 6 or 7 year horizon, to “asap”.
A second asset fire-sale is a relatively low level consideration, There are more structural concerns being expressed about the scale and speed of the proposed risk-transfer.
The FT also quotes the Bank of England’s executive director for insurance supervision, Charlotte Gerken In a speech in April, wh0
cautioned that the “structural shift” in the provision of retirement income gave insurers “an increasingly important role as long term investors in the UK real economy”. She called on them to exercise moderation “in the face of considerable temptation” and warned that some bulk annuity providers were expanding their risk appetite “outside their current core expertise”.
The “bonanza” offered to insurer’s new business departments may end up stretching them both from an operational and capital funding standpoint.
The Brave new world post solvency II
There has been much talk of the Brexit dividend, some of it in the world of insurance.
Insurers argue that the repealing of EU Solvency II legislation will eventually put them in a position where, like occupational schemes (and superfunds) today, they can invest in productive capital without being caught by the matching assets rules. Productive Capital in this sense might include equity (private or listed).
This might free them up to invest money from buy-outs and buy-ins in a similar way to occupational pension schemes – at least schemes that still have “growth” as an investment strategy.
And to give insurers their due, they are moving towards an investment approach which is aligned to the values of ESG,
According to this information, a move to insurance will radically change the asset backing of the pensions paid to us even prior to the easements though the emphasis is still primarily about debt rather than ownership.
Wtw survey on types of asset classes insurers use for bulks. Average portfolio shown has no gilts at all. https://t.co/Q2pX9GnChW pic.twitter.com/gzmtMpLkOS
— Sharpe Actuary (@Sharpe_Actuary) July 10, 2023
So Chancellor Hunt may be in for a nasty surprise if north of £60bn of DB corporate assets transfer from gilt-driven strategies to those indicated above. Insurers are offering an alternative approach to DB liability management but it is very far from the “risk-free” gilts based approach favored by regulators and – it would seem – the Chancellor.
And BP deferred and current pensioners might well be asking what upside they are actually getting in transferring to an insurer, whose actual risk-taking is likely to be relatively small compared to the risk outsourced through reinsurance to a global market.
Add to these risks, the self-evident risk of moving from a mutual to a shareholder model which requires shareholder reward and the price for appeasing the FD looks high. If estimates of insurer margins running at 20% are correct, there is a very real question over whether buy-out is value for money.
Is this what Charlotte Gerken is thinking of? Is it what members of DB pension schemes should be concerned about? If the risk transfer from DB to buy-out is not actually reducing investment risk – where is the upside for the member?
If I were at the Mansion House tonight…
I would be asking whether the Treasury is intervening in the wrong parts of the pension debate.
The consequences of risk transfer to insurers is happening now, unlike the proposed re-risking of DC pensions. The scale of the risk transfer is huge (£30bn in one deal – £600bn likely to move by the end of the decade).
I would be asking the Chancellor , the question Charlotte Gerken was asking of occupational schemes.
“Is this risk transfer really a win-win?” and if so “who are the win-winners?”.
Interesting piece Henry and the FT has done a great job here too.
It is not clear to me that members should expect to ‘win’ from the buyout, as long as their accrued benefits are better protected and likely to be above PPF levels. Major winners are the employers who no longer have this balance sheet risk. Members would be unlikely to get better benefits, even if the employer scheme did well and, in any case, the costs of DB have clearly meant workers still accruing or deferred in DB schemes with an employer are being effectively paid far more than newer colleagues who are stuck in DC. Clearly the other winners will be insurers, who are making huge profits, without proper transparency on their pricing or asset backing structures.
Taxpayers are perhaps those who will lose out, if DB employers have to put such large extra contributions into their schemes, costing billions of pounds a year, without necessarily an economic or social benefit for them. Yes, more pensioners will have higher pensions and therefore less likely to call on the State in retirement, but with the new State Pension supposedly aligned with PEnsion Credit levels, this may be less of an issue in future.
If DB schemes and insurance buyout funds are not supporting gilts – who will absorb Bank of England sales, or just lack of purchases, as QE unwinds?
UK pension funds should be urgently encouraged to back Britain. The longer that does not happen, the worse the outlook for UK growth and the more of the £70bn a year in tax/NI relief for pension funds will leak abroad.