The bulk purchase annuity market comes under the scrutiny of the FT this morning. They are reporting what we have heard rumoured but have had no solid evidence of. The insurers say this has nothing to do with the leveraged LDI crisis that happened when pension schemes borrowed to make them look solvent. We learn it is about winning new business buying out defined benefit pensions.

Good on the FT for giving us this.

This is concerning, we have been here before and it is right that the PRA takes early action to ensure we do not see something going wrong. Those who were in pensions and now being paid annuities have different rights, are protected by different regulators and different restitution, much of which is untested.

If the transaction simply “buys in” to the pension scheme and takes on liabilities while the scheme remains, then it is different from a “buy-out” where the scheme is released from the liabilities. There’s an interesting question of liabilities for the PPF, the PPF are responsible for what happens when the scheme exists. It is for FSCS to pick up the pieces if an insurer blows up,

The FT are not shy in naming names

Legal & General, Phoenix Group and Pension Insurance Corporation are among the firms using gilt-backed derivative trades after a collapse in the gap between corporate and government borrowing costs threatened the profitability of “buyout” deals, where insurers take over big chunks of companies’ pension liabilities.

But it is the absence of alternatives to buy-out which is worrying. In 2017 the Government announced superfunds as that alternative, to date only one superfund has been sanctioned (Clara) it has but a handful of schemes and is tiny by comparison to Bulk Purchase Annuities.

Such transfers, running at £40bn to £50bn in assets annually in the past few years, have become big business for insurance companies, who typically reinvest in riskier corporate debt and other long-term assets to eke out profits. But they are increasingly turning to the leveraged gilt strategies, market participants say, as the extra yield offered by corporate credit has shrunk.

Where are the superfunds when you need them? They are unable to get over the line due to difficulties with legislation (unfinished and still not allowing them to be properly commercialised) and regulation (which has made progress of early superfunds to give up).

So we are left with insurance that is beginning to worry actuaries as well as pensioners like me.

That has raised parallels with the leveraged pension fund bets at the heart of the gilt market meltdown sparked by former prime minister Liz Truss’s borrowing plans three years ago. “If insurers were to use these excessively . . . they could store up those kind of [liquidity] risks for the future,” said Gavin Smith, a principal at consultancy LCP.

One consultant who knows more than most (here’s the actuary to Clara ) politely explains how it works for insurers.

Calum Cooper, a partner at consultancy Hymans Robertson, said insurers were finding that they got a better yield on gilts than credit, once their capital requirements had been taken into account. “A natural extension of this is responsibly managed leverage to enhance the yield,” he added. The popular trades, which include the “forward gilt trade” and “par-par asset swaps”, are bets structured by an investment bank that involve wrapping a gilt — an ultra-safe asset with a low capital charge — in a derivatives structure that offers higher cash flows than the bond, but also builds in more leverage.

If that sounds complicated, then you are not alone! But we have been here before on this blog when Con Keating and Iain Clacher were pointing what would happen if leverage wasn’t properly understood. That was in early 2022 and we know what happened then.

An executive at a bank carrying out these trades said while so-called forward trades were quite conservative, the par-par asset swap trades were up to three times levered, with different structures being developed to allow insurers to hold less capital and aggressively compete on pricing.

I’m old enough to have been through another pricing war by insurers selling annuities, this time in the retail market. The with profits policies that contained guaranteed annuities came to a sorry end a quarter of a century ago, long enough for us all to forget – well nearly all.