UK Trustees are concerned about the growing involvement of overseas reinsurance firms in corporate #pension deals https://t.co/Xo8UBcLD41 via @ft

— Josephine Cumbo (@JosephineCumbo) February 4, 2024

It is important that we learn our lessons.

For more than a decade, the trustees of defined benefit schemes collectively considered “de-risking” to be about immunising pension schemes from the risk of interest rates falling, triggering a rise in notional liabilities that could lead to insolvency not just in the scheme but in the sponsoring company. This risk was considered so critical that trustees were prepared to borrow up to seven times the true value of some securities to satisfy the demands of the regulatory process. When the interest rates rose schemes were exposed to demands for return of borrowed capital and hadn’t the liquidity to make these cash-calls, Schemes had to sell off assets in a hurry and some failed to meet their obligations, losing their hedges and much of their asset base. For them de-risking turned out to have created new and frightening risk.

I am sorry to have to restate this, but it’s clear that the group-think that led to blind adherence to the concept of LDI is at work again, and again it is being introduced under the catch-all phrase “de-risking”. De-risking now means ridding the pension scheme of future liability by exchanging assets for a promise to pay pensions by an insurance company, This exchange is being conducted on terms favourable to insurers because the insurance industry has for a second time taken command of the agenda and created heterodoxy that could otherwise be called “group think”.

There are numerous examples of how insurers are exploiting their control and command

1. The practice of demanding “exclusivity”. Insurers now use consultants to organise many bids for takeover of a scheme through a demand for an exclusive right to quote. They argue that a completive tender for buy-out or buy-in would make it un-economic for tenderers to quote. The market becomes “take it or leave it”, trustees and employers find themselves under pressure to take it and the cost of buy-out is unquestioned, fair value is abandoned for expedient execution of the deal.
2. The use of funded reinsurance. Funded reinsurance differs from traditional reinsurance contracts in that the insurer isn’t just swapping out unrewarded risk to a third party (who wants that risk), the insurer is effectively selling on both liabilities and assets. Selling on the liabilities with the assets is both profitable in itself – if the new covenant is with a reinsurer who is providing less security at a lower price, but it is also freeing up the primary insurer to do more deals which are likely to also involve a weakening of the promise to pay, Funded reinsurance is a means to dilute the quality of the promise to pay pensions at the expense of the purchaser of the buy-out, the trustees. The trustees are of course committing money paid into the trust by the taxpayer , the sponsoring employer and the member.
3. A fundamental lack of transparency on pricing. The means of justifying insurance pricing is simply not in place. Whereas in other parts of financial services, the cost of services is clearly available , in the buy-out , the price is what it is and unchallengeable. Insurance companies can justify it by arguing they are taking on risks of people living longer than expected, that data passed to them is suspect and that the assets in the scheme cannot be realised at full value. The fundamentals to the price, the valuation of the liabilities is typically based on tables produced by the CMI, a part of the IFOA that is supposed absolute in its integrity. But giving any body the inviolable right to be right is a risk in itself, the ultimate arbiter of the life expectancy of the nation is the Office of National Statistics who tell us what is happening in life expectations, not what is likely to happen,

The last time a serious look was taken at the practices of a sector of the institutional pensions market was by the Competition and Markets Authority (CMA) who looked into the fiduciary management market and found it riddled with conflicts that led to asymmetric purchasing where the power was with the sellers and the buyers were offered services on take it or leave it terms. This led to action by the regulators.

No CMA investigation was held into the selling of LDI into the occupational pension schemes despite it being clear that there was market failure, at least among small schemes.

There seems to me that there is mounting evidence that a small number of insurers and reinsurers have a grip on the current “de-risking” market and have captured everything from the language of the discussion to the terms offered to buyers. A small group of experts own the advice, the pricing and the argument. Once again, the Pensions Regulator is not challenging this. It is left to journalists in the FT to point out the risks of reinsurance, the hegemony of the CMI tables goes unchallenged, the practice of exclusivity appears to be consider “pragmatic” and there is simply no disclosure of the profitability of this deluge of deals to the insurance and reinsurance sectors.

Meanwhile, terms such as “regulatory arbitrage” continue to be flung at any organisation that encourages DB schemes to run-on , either through capital backing, through superfunds or through the good management of sponsors and trustees. The insurance industry has so captured the argument, that schemes willing to value future liabilities with reference to best estimates on the returns of a balanced portfolio of assets are being stopped from doing so , under pressure from the draft DB funding code, the revised DB funding regulations and what looks like being a final code that will miss the opportunity to allow DB schemes to run on.

The CMA, PRA and FCA have good reason to look at the bulk annuity market and ask whether the insurance industry is being allowed to price as it likes in a captive market. I hope that this Government will encourage it to do so, and expect the next will pick up the cudgels if it doesn’t.