Pension Risk Transfer (PRT) and the Triumph of the Life Insurers

Are you OK with that or should you “Run On 4 Good?

Look at the maths and your financial best interests when discretion is exercised to see how all stakeholders can share in the economic benefits now enjoyed by life insurers instead.

A Brilliant Business Model

PRT has developed rapidly.  Well over £40 billion a year of pension liabilities are being transferred to life insurers by UK defined benefit schemes.

It happened because the life insurers have had a brilliant business model:

• Agree with DWP / TPR that the Gold Standard is to give them in cash all the money needed to meet liabilities to members.
• Agree with HMT / PRA you can invest that money at around gilts plus 1.5%.  Agree with PRA that, through the “matching adjustment”, they may take future profits as regulatory capital today.
• Reinsure longevity risk with often offshore entities to reduce regulatory capital commitments.
• Convince trustees your policies are “absolutely secure” and “guaranteed”.  In contrast, say the sponsor may fail at any time, subjecting members to unquantified, frightening PPF hair cuts to benefits.

This business model has been a remarkable success.  And it has all been made possible by regulatory gaps and arbitrage.

Life insurers have had a great run.  The rise and rise of PIC to be worth £5.7 billion to Athora just from managing pension money sensibly in a low risk way is remarkable.  But with so much easy money being made there are new entrants seeing the opportunity.  They just hope they are not too late to the party.  That may depend on how quickly Government, sponsors and members wake up.  Here are notes on their positions:

1)  Pensioners and Deferred Members:  The buyout trade means giving up a lot for what may prove an inferior position

Lose:

• S75 claim on sponsor to fund scheme fully over time
• Discretionary payments: becoming easier to make
• Interest in independent and well funded scheme – not in need of help
• Stop loss of PPF:  Covering payments of a large, rising proportion of liabilities.  Probabilistically negligible risk.

In exchange for: 

• FSCS insurance back up from the financial service sector scheme – unfunded, untested and with no Government guarantee.  Life insurers play up their close, regulatory links.  

For well funded schemes the risk of loss is low because the scheme is unlikely to need more money and the sponsor provides a full backstop.  In a financial services sector crisis, FSCS offers agreement to agree to pay in full: but no stop loss without an agreement.  PPF offers a stop loss linked to all schemes.  Less concentration risk.

2)  For Government:  Go where the money is.

DB schemes have large sums to invest which, if they stopped readying for buyout, could have a growing allocation to UK productive asset allocation right now.  Realise life insurer lobbyists are outstanding with their “leave it to us” tactics.  They encourage the long grass approach on both DC and DB policies.

So: 

• State strongly schemes must compare bulk transfers with run on as per TAS300V2.1.  There will be scrutiny of the actuarial work.  The numbers address fiduciary duty for trustees and bring a corporate strategy rethink.
• Where they are Mansion House compliant on asset allocations, incentivise schemes to use discretion to make payments to members and fund current pensions.
• Say you want to reconnect the past (DB) to the future (C)DC provision – in better pensions for all. Consider whether the regulatory arbitrage has been so market distorting that a windfall profit tax is appropriate.

3)  For Sponsors:  Get stuck into:

• A long-term Framework Agreement to provide an income stream upside and deal with residual volatility.
• Provide, if needed, guarantees to cover perceived risks and obtain insurance against being asked for funding while the Framework Agreement is in place.
• Consider the HR and ESG upside when you “Run On 4 Good”
• Ensure accounting for the transactions works to best.  Pay attention to the Framework Agreement.
• If taking the scheme “off balance” sheet is required, go for the bulk transfer with value share option.  New partners take over the sponsor funding back up role in whole or part.  The share for members remains.

4)  For Consultants:  ARGA Heat:

With a statutory body ARGA finally providing some scrutiny of actuarial work, it could be a good time not to look in thrall to life insurers.  IFoA can start with examining the conflicts of interest of its subsidiary which produces longevity tables.  

5)  For UK Capital Markets:

“Derisk and get rid ASAP” has overshot.  A long term, sound asset allocation will bring money into UK capital markets and bolster UK investment.  The role of life insurers becomes proportionate to what it adds.  The PIC deal can be the catalyst for a refreshing policy shift.  Propose pension transactions be transparent.  Numbers need setting out and a rationale provided.