This time last year I was reading about 2024 being a bumper year for buy-ins and buy-outs. The link’s to an excellent WTW report which is partially a marketing document for the months to come. It was published in January 2024. This January I am reading about how the back-end of the year saw the cost of swapping pension funds for bulk annuities go through the route. The result has been lower levels of buy-ins and buy-outs and a new interest in providing pensions (as was originally intended by sponsors and trustees when the schemes were set up.
Instead of WTW, I have read a difficult report on what is going on to make it difficult for trustees and sponsors to say yes to offers from insurers. Here it is . Schroders talk about something called the Z spread. I don’t know why but what it tells us is the increasing cost of buying insurance companies debt (including equity release and other products we may have heard of) relative to the selling price of 10 year gilts (which are falling fast).
Anyone who is listening to the news on Rachel Reeves going to China, will hear that the Telegraph readers (what I consider financially sophisticated conservatives) want Rachel to stay at home and prune the garden.
The Schroder report implies that the cost of switching from pensions to annuities is increasingly expensive. There are a few schemes that have gone ahead (like Compass) but not many.
This should please the Chancellor and the Pension Ministers whose mantra is “growth”! Let us remind ourselves that pension schemes that Buy in and then Buy out are decreasing demand for gilts (which HMT needs to see bought and not sold) and decreasing investment in long term assets (equities and the ownership of productive infrastructure).
Far from “de-risking”, the promised move of DB into bulk annuities would have resulted in a disaster for Britain. This is what Rachel Reeves is telling the world. She is looking for what Mark Carney called gilts reliant on the “kindness of strangers”. We are looking for China as a source of kindness. It goes beyond gilts – Reeves wants to see growth and I hope that Emma Reynolds (one foot in DWP , one in HMT) is thinking about the implication of “de-risking” of pensions.
If we want to see DC delivering growth , then it should be getting the surplus from DB. This DB is not quite what TPR claim- closer I suspect to the 94% funding suggested by PPF or the lower figure of ONS. Whatever the overall figure, there are schemes that have surpluses and companies that fund DC pensions along with DB plans.
The solution is to allow DC to be funded by DB and for provident sponsors to be spared the demand for increased DC contributions which is coming from the commercial master trusts and the “WEALTH” industry.
My view is that redistribution of DB wealth should help the 60% of British workers who aren’t worrying about IHT or working out how to get Pension Credit. Winding up DBs schemes into bulk annuities is closing down the door to pensions and denying us national growth and demand for gilts.
I am sorry this sounds a little simplistic. Having read the Schroder’s paper I thought something right for the 60% was due. You will be aware that I am recovering from brain damage but I hope you agree with me that those who take decisions on DB funding are taking a different view – it is a better view and it should be publicised.
If we consider the very much diminished private sector DB Funding universe, the bulk purchase of annuities not only reduces the asset base of the sponsor but as a result increases their future employment costs.
If we assume that the cost of the buy-out and buy-in matches the (PPF/TPR) solvency valuation assumptions, itself increasing challenged by the erosion of the credit risk premium, then the assets required (As con Keating points out) are for most schemes something just short of 40% more than those which the best estimate (? the neutral valuation) suggests would be required to run the scheme on. Depending on the level of gearing, those schemes which have LDI assets have seen the realisable value of their assets fall as the yield on the matched gilts rises creating a greater requirement for deficit recovery contributions to reach the solvency required for the risk transfer transaction.
The risk transfer salesmen, whether in the insurance companies or in the wider pension industry (? and Regulators) have been highlighting that those pension schemes which have been remained invested in growth assets have seen the realiseable value of their assets approach a level that matches or exceeds those required for the risk transfer transaction (the funding level). If however the assets, whether by additional contributions or merely not having been invested in assets matched to the falling gilts, are at that level they will be at 40% over the best estimate of those required to run the scheme on. There is therefore minimal risk to the members of those schemes of sponsor failure – so from their point of view a buy-in or buy-out is not a risk reduction exercise.
The Employer with a pension scheme with sufficient assets to meet solvency funding levels is almost certainly likely to be reporting a pension scheme surplus under IAS19 (with the liabilities discounted using the AA Corporate Bond yield at the accounting date). In the following year, the sponsor has a Profit and Loss credit equivalent to the the yield percentage of the surplus (? c.5.5% at 31st December 2024) at the preceding year-end. This applies whether or not an asset value ceiling has been applied (ala NatWest) to reflect an expectation that the surplus will be swallowed up by a future buy-in or buy-out transaction.
If the employer uses the run-on surplus of the DB scheme to fund future DC contributions, the profit and loss cost of the DC contributions is reduced but this is offset by the reduction in the surplus on the DB Scheme and the interest credit in the following year.
If however the employer continues to provide or restarts DB benefits from the pension scheme not only is the interest credit retained (and the surplus itself will should generate additional future surpluses) but the past service surplus can be used to reduce the future current service costs both in on P&L A/c and cash bases. Further the maintained employee contributions will account for a larger proportion of the current service costs.
The same principles apply even if a pension scheme has not reached solvency levels of funding. In this case provided the additional pension liabilities created in the year have a lower valuation costs than the contributions paid in during the year (Employer regular plus deficit recovery plus employee) the interest charges to the sponsor P&L A/c will diminish year on year with the reduction in the accounting balance sheet deficit.
Should shareholder activation challenge t employers that are paying too much to reduce or eliminate possibly non-existent risks and not taking the opportunity to reduce their future employment costs by running on and reopening to DB accrual?
Great post- thankyou
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Hi Henry. I am not sure where you got your facts from but over H2 2024 we saw some of the best buy-in pricing in years and we expect buy-in volumes over 2024 to be at near record levels (c£45bn). We agree with you gist in that we are seeing a trend towards more schemes considering run-on for a period. But that’s for other reasons – not because buy-in pricing hasn’t been good!
For more details, see page 3 of our PRT Outlook for 2025, which discusses buy-in pricing:
https://www.lcp.com/en/insights/in-brief/lcp-s-predictions-for-the-uk-pension-risk-transfer-market-in-2025