The U.K.’s fledgling pensions buyout market has enjoyed impressive growth over the past two years, as companies move to transfer the risk of their defined benefit obligations to insurance firms, either by buying annuities or by selling control of the schemes. Last year companies transferred £8.2 billion ($11.6 billion) of pension assets, nearly three times more than in 2007, according to London-based benefits group Aon Consulting.
The economic and financial downturn has put a sudden brake on the business, however, at least in the short term. Transactions have slowed dramatically this year because of fears that the recession will make companies more likely to default on their debt.
That matters because many insurers invested heavily in the corporate bond market as a way of backing their pension liabilities, and the financial crisis has pushed the value of these bonds down sharply. “The traditional annuity business used to be quite boring, investing in safe but low-yielding gilts, but then insurers moved into corporate bonds as a way to increase returns,” says David Blake, director of the Pensions Institute at the Cass Business School in London. “The collapse of liquidity in the corporate bond market has hit this strategy hard.”
Also, many buyout specialists use corporate bond yields to calculate the price of buying or insuring a scheme, and the recent volatility makes it difficult to value transactions. “We have done no new deals since the last quarter, and I doubt we will write any for some time to come because the bond price is so uncertain,” says Mark Wood, CEO of Paternoster, a London insurance company specializing in buyouts. It holds about £2.4 billion, or a hefty 76 percent, of its assets in corporate bonds. The firm says it is discounting 67 basis points of yield on every corporate bond in its portfolio to cover the risk of default. Wood won’t provide exact figures, but he says the insurer has “substantial” assets to cover its liabilities.
Not all buyout firms are spooked, however. “Events in the market have made pension fund trustees more aware of risk, and many want to de-risk their liabilities as much as possible through routes such as insurance,” says Bob Swarup, a partner at £2.2 billion-in-assets Pension Insurance Corp. His group bought £1.1 billion of pension liabilities from television rental group Thorn at the end of last year — the U.K.’s biggest buyout ever.
The country’s defined benefit plans still have an estimated £800 billion of liabilities outstanding, notes Andrew Reed, director of defined benefit solutions at insurer Prudential U.K. in London. “That’s still an enormous pie,” he says. Enough to keep banks and insurers salivating.
