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How will the superfund market impact the buy-in and buyout market?

Pension Board and Trustee Consulting|Pensions Corporate Consulting|Pensions Risk Solutions|Pensions Technology
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By Shelly Beard | September 28, 2020

Shelly Beard explains why the arrival of pension superfunds is not keeping the insurers awake at night.

One of the questions I get asked frequently at the moment is what the buyout insurers think of recent developments in the superfund market. The answer is, of course, that it varies from insurer to insurer, but if I had to choose one word to describe the overall view, I would go for ‘indifferent’.

Of course the insurers are keen to ensure everyone fully understands that the security offered to members via an insurer buyout is significantly higher than that offered by a superfund. Whilst superfunds are expected to be materially cheaper than an insurance buyout, this is because they do not offer the same level of certainty that members’ benefits will be paid in full.

That aside, I think it’s fair to say that the introduction of superfunds is not keeping the insurers awake at night, for several reasons:

  1. With £2 trillion of defined benefit liabilities in the UK, and only a small percentage of these insured so far, there is space for both the superfund and insurance markets to grow in tandem for the foreseeable future.
  2. The Pensions Regulator has made it clear that schemes where buyout is a feasible option should not be considering superfunds. Assuming the Regulator’s interim regime operates as intended, it’s therefore unlikely that there will be many cases where superfunds and insurers are competing against each other. Whilst recent economic turmoil has, unfortunately for those involved, led to sponsor covenant concerns for some schemes, and therefore an increase in schemes who are considering superfunds, these schemes were unlikely to have been considering an insurance transaction in the medium term in any case.
  3. Everyone recognises that the inefficiency of small pension schemes – both in terms of costs and their reduced ability to run optimised investment strategies – is an issue across the industry. In fact, the insurers themselves incur greater expense when trying to price small deals. Whilst superfunds are initially targeting larger deals so they can build scale, it is expected that in the longer term they will also target smaller pension schemes and this consolidation should provide a more efficient future for small schemes, which is good for everyone in the industry.
  4. Some superfunds are targeting moving schemes to buyout – and so will be future customers of the buyout insurers. Indeed, some schemes may even reach buyout quicker under the professional stewardship of a superfund.

Sitting alongside these reasons is the fact that the insurers know that for most trustees, the tried-and-tested path of an insurance buyout firmly remains their preferred outcome for their schemes.

That said, there are several scenarios where superfunds are likely to provide better outcomes for members. For those of you who attended our seminar ‘Superfunds – a new era for defined benefits’ back in June you’ll remember we asked participants to consider what they’d do if their sponsor was insolvent and they were only 90% funded on buyout – (1) secure 90% of benefits with an insurer; or (2) secure 100% of benefits with a superfund. As you can see from Figure 1 below, responses were divided and certainly many trustees and pensions professionals could see the advantages of superfunds in this scenario.

Figure 1. If your scheme employer became insolvent and your scheme funding level was 90% of buyout, what would you do?

60%
would secure 90% of members’ benefits with an insurance buyout. (Members are guaranteed a 10% reduction in benefits, but no more).
40%
would transfer the scheme to a superfund that promises to meet benefits in full, but with no guarantees. (If the superfund went horribly wrong members would receive 80% of benefits on average).

Whilst you consider what you would do given the same choice, hopefully I’ve convinced you that insurers and superfunds can coexist is relative harmony in the pensions industry going forwards. Which leads to another important question – will the first superfund transactions lead to insurers reducing the cost of buy-ins and buyouts? The answer here is a definite no – firstly because as set out above, the two different options simply can’t be compared. And secondly because the buy-in and buyout market is already very competitive, with all of the insurers seeking to optimise their pricing in order to win new business, whilst working within the confines of being in a very heavily regulated industry.

Personally, I believe superfunds are a positive development for the industry and I look forward to seeing the first transactions in the superfund market – in the meantime, there is no question that my day job as a buyout specialist will remain busy and rewarding.

Contact

Shelly Beard
Senior Director of Transactions

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