This article draws on information available in NatWest’s Market Insights into “Insurance Origination and Solutions”. More here.
We are used to stories about the surge in buy-outs in 2024 but NatWest ask a different question and suggest that the heralded boom – has not happened
A quiet first half…?
Anecdotally, those connected with the bulk purchase annuity (BPA) market had largely predicted that new business volumes for 1H24 may be relatively low (in the context of 2023’s £49.2bn for the full year, and similar expectations for 2024, at least).
This proved to be the case following firms’ interim results presentations, with published numbers perhaps even lower than some may have expected, despite strong volumes from Just (£1.9bn across 55 transactions) and Rothesay (£4.2bn in addition to its acquisition of the Scottish Widows £5.3bn bulk annuity back-book(1)).
So not quite the bonanza predicted. We are left wondering why…
Tight credit spreads influence pricing and asset allocation
As has been the case for some time, depressed public credit spreads continue to present premium deployment challenges for BPA writers. More recently, though, this has led to suggestions that transaction pricing could start to reflect expectations of credit spreads remaining tighter for longer (and increased allocations to gilts in the meantime).
So reduced capacity , leading to demand outstripping supply with implications on pricing
Our proxy annuity pricing model has enabled us to replicate historical transaction pricing data published by LCP. Extrapolating this under recent market conditions may indicate how pricing is evolving(2):
| Historical bulk annuity pricing with NWM indicative extrapolation
Source: LCP, NWM annuity pricing model*
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Dashed lines indicate NWM indicative extrapolation. So volumes down and the outlook looking worse.
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Far from being a boom-time for insurers, this appears to be a time of famine
In its interim results, PIC outlined that spreads had been “about as tight as they have been since the Global Financial Crisis,” meaning that “in [its] view, assets have been overpriced.” This, it said, meant that it had been “very selective in the assets that [it had] invested in,” though it did note that this had led to “opportunities to invest in higher rated assets at a lower relative cost,” allowing “significant de-risking of the [investment] portfolio”.
Even Rothesay, the mighty Goldman Sachs buy-out vehicle, is feeling the pinch.
Rothesay, a firm that has historically disclosed the impact of short-term premium under-deployment, seemed to have faced similar challenges, reporting a significant £411m reduction in surplus due to the “impact of temporarily being invested in gilts” over 1H24 (2023: £151m increase in surplus). “Solvency surplus,” it said, “is projected to improve … following reinvestment of the gilts received as part of BPA transactions.”
So where does this lead?
In some cases, this dynamic may be leading firms to consider structured options to help boost returns available on specific gilts. For example, by using swaps to convert index-linked gilts into fixed cash flows:
I had no idea what this kind of financial engineering is but it sounds very much like the kind of thing that has got us into trouble in the past.
Once again , the insurance companies seem to be falling back on their favourite means to employ “voodoo economics”
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Excuse me in my ignorance but this looks anything but safe |
The insurers are looking ahead
There’s plenty of chutzpah among the insurers but this does not sound like quite the win they were predicting this time last year
Despite these challenges, firms remain confident that annual new business volumes for 2024 will still exceed £40bn. Indeed, L&G cited its “strongest ever pipeline,” with PIC, Rothesay and Phoenix also noting significant volumes of business to transact over the remainder of the year. In a number of cases, firms placed additional emphasis on deals already completed in H2 as well as those currently “in exclusivity” during HY management presentations:
But with the eternal problem in sales; pipelines get blocked.
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The red lines don’t match the purple lines and despite a prognosis of a record year, sales volumes are well down with no great prospect of an uplift in final quarters (see chart one) |
The insurers are clearly in damage limitation mode
One factor likely to be key in determining 2024’s total volume will be the extent to which it is practical to complete deals over the remaining months of the year (and what proportion drifts into 2025 instead).
This is largely felt to be driven by prospective deals at the upper end of the market, with PIC’s Chief Origination Officer Mitul Magudia noting that differences in predictions for future market volumes may reflect “uncertainty about the timing of larger scheme transactions(6).”
The elephant deals – such as BP, haven’t arrived. Are the elephants endangering the pipeline?
The insurers have been issuing debt in readiness and the market has bought it
In the debt capital markets, key market themes from H1 persisted throughout much of Q3, as a relatively stable macro backdrop and strong investor cash balances made for supportive issuance conditions. This generated a range of insurance sector supply across Tier 2 (T2) and Restricted Tier 1 (RT1), from both regular issuers and, perhaps, more peripheral names:
- In September, Aviva undertook a prudent early refinancing, with its Natwest-led T2 issuance (30NC10, 6.125%, £500m, T2) executed intraday alongside a concurrent tender offer for £500m of its grandfathered T2 bond (30NC25, 6.125%, £700m, T2). The new instrument priced with a spread 55bps inside the firm’s near-identical November issuance for a coupon 0.75% tighter, highlighting the strength of the current market
- September also saw fresh issuance from Just with a sustainability-linked T2 (10.5-year bullet, 6.875%, £400m, T2), alongside a tender offer for £232m of its £250m T2 instrument (10NC5.5, 7.000%, £250m, T2). Favourable market conditions were again apparent, with the firm boasting an orderbook that was c.2.5x over-subscribed to price at G+300bps. This may appear to be tight on a relative value basis to Phoenix’s 2023 issuance (30NC10, 7.750%, £350m, T2) which was rated one notch higher and at G+293bps around the time Just’s issuance was priced
- In Bermuda, NatWest also helped Resolution bring its inaugural bond offering to the USD RegS market (7-year bullet, 8.250%, $500m, BMA T2) in July in a bid to “strengthen [its] capital position whilst diversifying its investor base and sources of long-term capital.” The bond attracted a high quality final orderbook, standing at c.$1bn at time of pricing
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Across the rest of Europe, each of CNP Assurances (30NC10, 4.875%, €500m, T2), Allianz (30NC10, 5.600%, $1.25bn, T2), and Generali (10.25-year bullet, 4.156%, €750m, T2) were in the market with well-bid orderbooks
The quarter also saw a raft of other European insurers issue bonds(7), contributing to overall market buoyancy, with investors very engaged in primary and negligible signs of sector concentration. At the end of the quarter, we see year-to-date Euro subordinated supply up c.174% and Sterling up c.35% compared to the same time last year.
Everywhere you look , in the UK, Europe or Bermuda , there is a scramble for capital, but most of the money raised is “dry powder” – waiting to be invested.
The question is whether there are enough levers to pull?
Having raised money in anticipation, there is now evidence that insurers are having to pull in their horns.
Some firms also revealed plans for debt reduction, with Rothesay calling its £400m T2 (10NC5, 5.500%, £400m, T2) in September after it had initially reported £843m of hybrid capital “offside” at HY24
Capital “headroom” at HY24 Source: HY24 interim results presentations, FY23 SFCRs
NatWest report coyly
The redemption brings this figure down, but still leaves plenty of “dry powder” ready to be deployed in the future.
And like football clubs, insurers are now trying to meet the financial rules that govern them. They can only borrow so much against new business
More broadly, the interim results period saw firms continue to focus on managing (down) Solvency II leverage metrics, most notably in the cases of Aviva, Phoenix and M&G Having reduced its hybrid debt by £461m during H1, M&G stated that it expects to meet its 30% leverage target by 2025 (HY24: 32%) through “Own Funds growth”, without the need for further deleveraging.
Which is fine, so long as the new business is there.
These leverage targets, alongside relatively low new business volumes in H1, appear to have limited the extent to which hybrid capital issuance is currently being used to grow the capital base across the industry in general. This situation could still be set to change, however, should projected pension scheme de-risking volumes come to fruition over H2 and beyond.
As we approach the end of the year, it looks as if the insurers are faced with holding a lot of debt which is not deployed and sits as “dry powder”. The fundamental problem is that the pipeline is full with deals that are not getting done. The elephant deals like BP have not happened and it looks as if prices are going up not down.
All of which leads me to wonder whether we might not be better looking at pensions as pensions, rather than insured annuities.
Insightful as ever. Methinks the shutting down of the funded reinsurance market has had a big impact on pricing – and the use of scarce Equity capital by the insurers. No longer can the insurers manufacture capital by booking new business premia and transferring 90% of the risk offshore. Equity is scarce – Phoenix for example has only £200m available
Could it also be that TAS 300 V2 analysis is making it obvious to finance directors just how expensive buy-out is?
No need to project our insurer pricing chart from March – there is an updated version which runs to the end of September in our recently published risk transfer report (see page 19).
https://www.lcp.com/en/insights/publications/pension-risk-transfer-report
Interestingly it shows the opposite of the NWM analysis with non-pensioner pricing at some of its strongest ever levels. There also is some commentary in the report about the divergence between credit spreads and buy-in pricing over the summer.
As anyone connected to the BPA market knows, trying to extrapolate pricing based off market indicators is a fools game, and we fell straight into our own trap – if only you could have published a few days earlier, Ken!
Interestingly, part of the assumptions we used were based on comments that pricing was “looking more attractive” for insurers – which we took to mean “more expensive for schemes” (per the chart above). However, we now understand that this is more likely to be in the context of margins having improved (possibly, longevity reinsurance pricing-driven, I think LCP also talk about this) despite the front line pricing to schemes appearing “cheaper”.
Of course, that cheapening could also be driven by pressure to deliver volumes and a need to deploy some of the “dry powder”. Equally, there is another pricing chart out there from K3 that doesn’t necessarily seem to show the same trends as LCP – at least not to end-July – but perhaps that’s focussed only on a particular part of the market.
This was an interesting read, Henry – a sort of “Picasso” of what we’d originally written. Of course, Picassos leave lots of room for different interpretation…