Pension de-risking helps corporate sponsors and trustees remove or reduce the risk of additional financial costs associated with running DB pension schemes.
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De-risking market quarterly update: Q4 2012 Welcome to our quarterly update on the latest developments in the defined benefit (DB) pension plan de-risking market. We will be looking at all aspects of the market, including regulatory developments, product development, completed transactions, product pricing and market sentiments. We will also provide views on the future development and shape of the market. This continues to be an extremely interesting and dynamic time in the de-risking market, with activity continuing to be strong despite gloomier predictions over the time it will take for the economy to recover. In this update, we look at the last three months of 2012, including providing a background to some pertinent regulatory issues, the drivers behind recent de-risking activities, some innovative de-risking solutions that we can advise on and a preview of how we think the market will develop in the next six to twelve months. Regulatory issues in the market RPI averaging method On 8 October 2012, the Office for National Statistics (ONS) announced a consultation about the method used to calculate the Retail Price Index (RPI). There are two key reasons RPI is expected to be consistently above the Consumer Price Index (CPI). One is the underlying basket of goods and the other is the method used to calculate the average price. CPI uses a geometric average and RPI uses an arithmetic average, which has an upward bias of around 0.5% to 1% pa. The consultation proposed various options on how to reduce or remove this inconsistency. The results of the consultancy will be announced in January 2013, with anticipated implementation in March 2013. The impact of this change is dependent on whether a pension scheme's revaluations are in line with CPI or RPI. Depending on the option implemented, RPI expectations could fall dramatically. This will have three effects: 1) Index-linked gilts are based on RPI, so any fall in RPI expectations will be reflected by a fall in the value of any index-linked gilts 2) Any scheme with RPI revaluations will experience a significant reduction in liabilities. The overall effect will depend on the option chosen and benefit structure of the pension scheme 3) CPI-linked benefits will not change on an on- going basis. However, insurers do not currently have a large market in which to purchase CPI-linked assets, so often use RPI- linked assets as a proxy, which will be cheaper . Thus, this change could lower the costs of de-risking CPI-linked liabilities.
Transcript
De-risking market quarterly update: Q4 2012
Welcome to our quarterly update on the latest developments in the defined benefit (DB) pension plan de-risking market. We will be looking at all aspects of the market, including regulatory developments, product development, completed transactions, product pricing and market sentiments. We will also provide views on the future development and shape of the market. This continues to be an extremely interesting and dynamic time in the de-risking market, with activity continuing to be strong despite gloomier predictions over the time it will take for the economy to recover. In this update, we look at the last three months of 2012, including providing a background to some pertinent regulatory issues, the drivers behind recent de-risking activities, some innovative de-risking solutions that we can advise on and a preview of how we think the market will develop in the next six to twelve months.
Regulatory issues in the market RPI averaging method On 8 October 2012, the Office for National Statistics (ONS) announced a consultation about the method used to calculate the Retail Price Index (RPI). There are two key reasons RPI is expected to be consistently above the Consumer Price Index (CPI). One is the underlying basket of goods and the other is the method used to calculate the average price. CPI uses a geometric average and RPI uses an arithmetic average, which has an upward bias of around 0.5% to 1% pa. The consultation proposed various options on how to reduce or remove this inconsistency. The results of the consultancy will be announced in January 2013, with anticipated implementation in March 2013. The impact of this change is dependent on whether a pension scheme's revaluations are in line with CPI or RPI. Depending on the option implemented, RPI expectations could fall dramatically. This will have three effects: 1) Index-linked gilts are based on RPI, so any fall
in RPI expectations will be reflected by a fall in the value of any index-linked gilts
2) Any scheme with RPI revaluations will experience a significant reduction in liabilities.
The overall effect will depend on the option chosen and benefit structure of the pension scheme
3) CPI-linked benefits will not change on an on-going basis. However, insurers do not currently have a large market in which to purchase CPI-linked assets, so often use RPI-linked assets as a proxy, which will be cheaper . Thus, this change could lower the costs of de-risking CPI-linked liabilities.
De-risking market quarterly update: Q4 2012 January 2013
Autumn budget There were two major announcements made by the Chancellor of the Exchequer George Osborne in the Autumn Statement 2012: 1) The Government announced a consultation
on whether pension schemes undergoing valuations with dates effective from 2013 should smooth asset and liability values to reduce the effects of day-to-day volatility in deficits on the results of the valuation
2) The Annual Allowance (AA) and Lifetime Allowance (LTA) were reduced from £50,000 to £30,000 and £1.5m to £1.25m respectively. This will reduce tax relief for many middle and high income earners. Pension schemes should revisit the analyses they carried out when the AA and LTA were initially reduced earlier in 2012.
IORP It is apparent that Brussels is watering down some of the most onerous demands set out in its initial proposals, which could have seen UK DB pension deficits balloon by up to £350bn. A revised Directive is due to be released in June 2013. GMP reconciliation The Pensions Regulator (tPR) is encouraging schemes to use a £2 per week tolerance for setting Guaranteed Minimum Pension (GMP) amounts. This will significantly reduce the cost of data cleansing exercises. GMP equalisation Since the closure of the consultation in April 2012, there have been no further costs. However, Pensions Minister Steve Webb has stated that the Government may review its preferred solution to reduce implementation costs Accounting changes Pension schemes reporting under IAS19 will have changed requirements for reporting periods starting on or after 1 January 2013. These changes will significantly affect the P&L stated in the company's balance sheet.
Market news
Following patterns observed in previous years, December proved to be a busy month for transactions with over £2bn of business being written. Total business for 2012 will be considerably lower than 2011 levels, mainly due to a reduced volume in longevity swaps.
The current low yield environment has pushed up Bulk Purchase Annuity (BPA) prices, which as a result appear less affordable for many schemes. However decreasing yields also provide high returns for investors in gilts. Pension schemes that use gilts to hedge their pensioner liabilities have found that returns on their gilt investments have materially outstripped increases in the cost of a pensioner buy-in. Many such schemes have taken advantage and have cashed in their gilts to maximise the coverage they get from these assets. The table below is for general guidance and it is possible to get prices from the market that are +/- 5% for buy-outs and buy-ins. As scheme funding positions generally improve (despite short term volatility) it is expected that buy-ins will continue to be the dominant de-risking transaction in terms of volume in the market. Recent research suggests that buy-ins and buy-outs are now more popular than longevity risk hedging.
10% to 15% above actuarial Technical Provisions (using CMI improvements with 1.25% underpin)
Index-based longevity swap
Circa 5% above actuarial Technical Provisions (using CMI improvements with 1.25% underpin)
Deferred premium BPA
Initial price will be in line with BPA buy-out or buy-in pricing, but total premium payment (including lower initial premium) is likely to be higher than initial price due to longevity guarantee and/or interest on deferred premiums
* Bulk Purchase Annuity
Market sentiment
Investors and equity analysts are increasingly taking into account the risk management strategies of companies with DB pension funds. There is
evidence to suggest that the market responds positively to companies that have implemented a materially significant risk reduction strategy on their pension plan. See the table below for some examples.
Company
Date
Type of de-risking
Transaction size
Share price Before After
% change
Akzo Nobel May 2012 Longevity swap £1,400 million 40.69 40.93 0.6
Tate & Lyle December 2012 BPA
£350 million 756.5 769 1.7
Cookson July 2012 BPA
£320 million 607.5 633.5 4.3
General Motors December 2012 BPA
£230 million 25.63 25.56 -0.3
Aon Minet July 2012 BPA
£100 million 46.43 46.81 0.8
Outlook for the next 12 months
Bulk purchase annuities With many analysts expecting further Quantitive Easing in 2013 and predictions of an increasingly slow economic recovery, it seems unlikely that we will see any significant upwards movement in gilt yields. Assuming that this low gilt yield is sustained over the upcoming year, we expect that most BPA contracts will be related to pension plans cashing in on historic good performance of certain asset classes, such as bonds or deferred premium arrangements for those pension plans who need to rely on a medium-term pick-up in the equity market. Longevity swap market There was a rush of activity at the end of 2011, a year where around £7bn worth of longevity swaps was written. In the first half of the year many banks, such as Deutsche Bank, UBS and Nomura pulled out of the market, to be replaced by insurers
such as Swiss Re and L&G. Activity in the market has slowed due to this turnover in market providers and only two major deals were signed in 2012, both with Swiss Re. In a Solvency II framework, initial capital requirements are significantly lower for a longevity swap than a BPA structure, a feature that we expect to attract more insurers into the market. However, as longevity swaps often take some time to execute, it is possible that deals involving these insurers may not complete until the latter half of 2013. We also expect more plans to use a combination of solutions to tackle the different risks they face. Combining a pensioner buy-in and a non-retired index-based longevity swap with a liability-driven investment (LDI) overlay can lead to a de-risked position that is very close to a buy-out - a ‘DIY buy-out’, where the index-based longevity swap would have to be re-executed at the end of each contract term, usually every 15 years.
"A small risk premium is payable and the accounting deficit will increase slightly as a result. But this feels like good business to us" Investec commentary on Tate & Lyle's buy-in, 10 December 2012
"As the market edges lower, Tate & Lyle has bucked the trend after the group unveiled a pensions deal with Legal & General" The Guardian commentary on Tate & Lyle's buy-in, 7 December 2012
De-risking transactions in the last year The bulk purchase annuity deals struck in the last 12 months with a premium in excess of £100m are
listed below :
Date Pension scheme Counterparty Value
December 2012
Merchant Navy Officers' Pension Fund Rothesay £680m
December 2012
Tate & Lyle Group Pension Scheme Legal & General £350m
July 2012
Cookson Group Pension Plan PIC £320m
April 2012 West Midlands Integrated Transport Authority Pension Fund
Prudential £270m
December 2012
General Motors UK Pension Plan Rothesay £230m
May 2012
Gartmore Pension Scheme PIC £160m
July 2012
Aon Minet Pension Scheme PIC £100m
Total £2,610m
The major longevity swap deals struck over the past 12 months
Date Pension scheme Counterparty Structure: (indemnity or index-based)
Value
May 2012
Akzo Nobel (CPS) Pension Scheme
Swiss Re Indemnity £1,400m
December 2012
LV= Employee Pension Scheme
Swiss Re Indemnity £800m
Total £2,200m
Innovation
While a pension annuity buy-in remains the most popular insurance-based solution used to de-risk a defined benefit pension fund, Grant Thornton can advise on a wide range of new and creative de-risking solutions, which are tailored to the size, risks and requirements of an individual pension scheme. We offer independent advice on structured solutions and transactions that will either transfer
out or mitigate the risks faced by your pension scheme. Our work can help both privately-owned and listed corporate sponsors and trustees to reduce the risk of financial losses as a result of the pension scheme and concurrently give more protection for members' accrued benefits. We also play an important role in providing pensions advice in corporate Mergers & Acquisitions transactions.
De-risking market quarterly update: Q4 2012 January 2013
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Key contacts
Darren Mason Head of Pensions T +44 (0) 20 7728 2433 M +44 (0) 7971 434 964 E [email protected]
Kelvin Wilson Director, DB Pensions T +44 (0) 20 7865 2402 M +44 (0) 7879 667 208 E [email protected]
James Edelman Assistant Manager, DB Pensions T +44 (0)20 7865 2819 M +44 (0)7780 687650 E [email protected]
Darren has over 20 years' experience in corporate transactions and restructuring. He has led over 100 assignments flowing from the new legislation governing the stronger funding of defined benefit pension schemes advising on the impact for trustees, companies funding the schemes and their lenders. Assignments have included changes in covenant as the result of a transaction, clearance applications, employer covenant in SSF valuations, contingent asset solutions, covenant monitoring and restructuring involving scheme sponsors. Many of these assignments have included groups with overseas ownership including listed companies in the US, France, Germany, Malaysia, Japan and Australia.
Kelvin advises on bulk purchase annuities, longevity swaps, investment strategy (including liability driven investment strategies) and designing and implementing flight paths for schemes looking to achieve a target funding objective. Whilst at Prudential M&G, Kelvin helped structure the first £1bn pension annuity buy-in with Cable & Wireless Superannuation Pension Scheme. Kelvin holds an MA from Oxford University and has an actuarial and investment management background. He has performed, reviewed and analysed a number of valuations. He recently advised a purchaser about the appropriate level of price adjustment needed on a deal involving a defined benefit pension scheme.
James is a part qualified actuary with an MA from Cambridge University and an MSc from Imperial College Business School. He has worked with a number of corporates and trustees in the past on SSF valuation calculations and negotiations, M&A activity, risk analyses and implementing de-risking solutions. He now specialises in advising on pension scheme risks and how to manage these risks over the long term.
De-risking market quarterly update: Q4 2012 January 2013
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About Grant Thornton
Grant Thornton UK LLP is a leading financial and business adviser, operating out of 28 offices. Led by 215 partners and employing nearly 4,000 of the profession's brightest minds, we provide personalised assurance, tax and specialist advisory services to over 40,000 individuals, privately-held businesses and public interest entities. As a member of Grant Thornton International Ltd, we are one of the world's leading international organisations of independently-owned and managed accounting and consulting firms. Our deep-rooted experience in the issues affecting mid-sized businesses, combined with the true global reach and resources of Grant Thornton International Ltd, means that we're uniquely placed to deliver the best advice, in a seamless way - regardless of service line, regardless of location. Clients of member and correspondent firms can access the knowledge and experience of over 2,500 partners in over 100 countries and consistently receive a distinctive, high-quality and personalised service wherever they choose to do business.
About Pensions Advisory
Pensions Advisory offer independent advice on structured solutions and transactions that will either transfer out or mitigate the risks faced by your pension scheme. We can advise on a wide range of new and creative de-risking solutions, which are tailored to the size, risks and requirements of an individual pension scheme. Our work can help both privately-owned and listed corporate sponsors and trustees to reduce the risk of financial losses as a result of the pension scheme and concurrently give more protection for members' accrued benefits. We also play an important role in providing pensions advice in corporate Mergers & Acquisitions.
De-risking market quarterly update: Q4 2012 January 2013
