Pension risk transfer market: Entering unchartered territory

The UK pension risk transfer market is arriving at a unique juncture, driven by evolving supply and demand factors, regulatory change, and macroeconomic and capital market volatility. The impact on end game strategies could be far reaching.

Transferring benefits to a life insurer has long been seen as the ‘gold standard’ for delivering defined member (DB) pensions. Between 2018 and 2021, over £125bn of buy-in and buy-out transactions were written, with demand expected to increase even further (current market consensus indicates that up to £50bn of transactions a year could be expected over the next decade). Whilst the insurers in this market have underlined their confidence in being able to meet this challenge, some market commentators have questioned whether there will be sufficient supply in the current market.

Against this backdrop the UK life insurance regime is about to undergo potentially significant change; the UK Government’s consultation on proposed changes to Solvency II remains ongoing and, whilst there is market consensus over many of the proposed changes, uncertainty remains over what is arguably the most important component – the Solvency II Matching Adjustment – which, in effect, allows insurers to provide cheaper insurance by taking advance credit for at-risk returns. This, and the resultant overall changes to UK insurance regulation that follow, could have significant ramifications for UK life insurers and DB scheme members.

On top of this, life insurers find themselves navigating a macroeconomic climate that has not been experienced in over 40 years – high inflation, coupled with the Bank of England’s recent recession warning, means that the UK could be heading into ‘stagflation’. As such, insurers could see the quality of their investments deteriorate through increased credit downgrades and defaults.

Furthermore, any insurers looking to raise hybrid debt capital in the near-future may experience higher borrowing costs than in recent years, whilst any increase in volatility in interest rates and credit markets could create pressure on liquidity management for insurers – we saw this dynamic during H1 2020, following the first COVID-19 lockdown, when insurers faced an increase in collateral calls on their derivative instruments.

As a result, trustees and sponsors will need to put more focus on understanding their insurer’s financial strength, risk management and capital resilience when undergoing an insurance-led risk transfer exercise. For schemes adopting a phased insurance approach, monitoring their buy-in provider should form part of their regular risk management process which, when it comes time to consider a further transaction, will help to inform whether their existing insurer remains the most secure option for their members.

Read the full Covenant Quarterly Q3 2022 which also includes the following articles:

• Datawatch: Credit default swap (CDS) spreads
• Ask the Analyst: Why is it important to consider the impact of macroeconomic volatility on covenant strength
• Regulatory developments: £1bn schemes within TCFD and climate change governance scope from October 2022

For more information contact Michael Luo, Director