The risk transfer market - by which we mean defined benefit pension schemes securing their liabilities through buy-ins or buy-outs with insurers – has seen continued high levels of activity during the Covid-19 lockdown period . At Mercer we’ve advised clients on twelve completed transactions since the lockdown period began, covering around £4billion worth of liabilities.
Understanding what was driving this activity in volatile economic conditions can offer some helpful ways to spot further opportunities in future months.
The risk transfer activity seen over recent weeks resulted from attractive insurer pricing which was driven by the increase in credit spreads, by which we mean the difference between the yields on corporate bonds and government bonds. The spike we saw in credit spreads when lockdown started led to some very attractive risk transfer pricing. Some of our clients saw improvements of 5-10% in the price quoted for transferring their pension scheme to an insurer, compared with quotes received before the volatility began.
The price for a buy-in or a buy-out of a pension scheme is driven by the returns on the assets which insurers can buy any a point in time, adjusted to reflect their regulatory requirements to hold a reserve on top of those assets to cope with potential underperformance.
Corporate bonds, which underline credit spread, have been a favoured go-to asset for insurers to back buy-in pricing and the credit spread widening led to better pricing. Credit spreads have since come back down but remain at a level which is still driving relatively attractive pricing compared to previous years.
Whilst corporate bonds were a key asset class for producing strong pricing in Q2 2020, there are two other asset types favoured by insurers in recent years which we might expect to see increased buying opportunities for insurers later in the year, and in turn could offer advance notice of potential risk transfer price opportunities.
One is infrastructure. These are long-dated assets that are fairly illiquid, but with the possibility of a recessionary period over the coming months, the government has already instigated acceleration of economic recovery by encouraging institutional investors like insurers to invest in infrastructure. As these opportunities appear this could feed through into potentially good buy-in pricing. Watching out for continued government announcements might give us a few weeks or months head start on when that pricing is likely to come through and allow us to forecast potential opportunities.
The second asset favoured by some insurers is lifetime mortgages, which a number of insurers have invested in to back their pricing over the last two or three years. Over lockdown that market has been on pause because it was difficult to perform valuations on properties. But over the coming months, and with economic uncertainty causing job insecurity, many homeowners may turn to equity release as a method of accessing liquidity. That can feed through into investment opportunities for insurers to pass on to buy-in pricing. In terms of early indicators, watch out for any government announcements around employee support schemes, which can be seen as an indicator for when activity in this market may increase.
Whilst we can’t forecast timing with certainty, we can ensure we are prepared to react in a nimble manner. Over the last few months, the schemes that have done well are those that have completed a previous risk transfer exercise such as a partial buy-in. When we saw attractive pricing due to corporate bond movements, they were able to act very quickly to take advantage.
For schemes not in that position and which haven’t done a previous buy-in, there are several steps that can be taken to put themselves in a similar position and be at the front of the queue for the next wave of attractive pricing. In particular, considering schemes who have already completed transactions, they have:
There’s no reason why other schemes can’t gear themselves up to be ready for opportunities that appear by preparing in these areas. 2020 is very unusual; we could see positive price windows appearing from time to time, and we may even have advanced warning. The ability to plan ahead and act quickly is a sensible strategy for all schemes to adopt, both for this year and in future.
If you would like to talk to someone about any of these issues, contact Ben Stone on 07557 031694.
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