Up until recently, solvency funding positions of a vast number of UK defined benefit pension schemes were estimated to be in deficit, meaning that the value of the assets held was expected to be insufficient to cover the cost of insuring the benefits of the pension scheme with a UK life insurer.
Over the period from December 2021 to end of February 2024, the expected coverage of assets in comparison to the expected insurance costs has increased from 69 per cent to 100 per cent.
The largest contributor towards the improvement in coverage is the material movements observed in the financial markets with regard to gilt yields.
This included a frenzied period during September and October 2022, coined as the 'gilts crisis', which refers to the sharp rise in gilt yields following the now infamous "mini"-Budget, involving unfunded tax cuts and significant future government borrowing requirements.
Heightened volatility, albeit to less extreme levels, has continued in the gilt market since, with yields having reached record highs since the global financial crisis in 2008.
Higher gilt yields generally improve pension scheme funding levels as they imply a higher return on invested assets.
The improvement in pension schemes’ solvency positions has meant that many pension schemes are now looking to secure their positions by seeking insurance transactions within the bulk annuity market.
This means paying a UK life insurer a premium in exchange for the insurer taking responsibility for the payment of members’ current and future benefits.
Over the course of 2023, the bulk annuity market experienced a surge in demand following the rise in gilt yields with transaction volumes hitting a record high of around £50bn in annual premium.
This was a significant increase from the circa £28bn written in 2022.
The transacted pension schemes in 2023 include well-known sponsors such as Virgin Media, Mitchells & Butlers, Harrods, Co-op, RSA, Boots and many more.
There are two broad types of bulk annuity insurance solutions adopted to secure pension scheme benefits: buy-in and buyout.
What is a buy-in?
In brief, a buy-in is a bulk annuity insurance policy that sits as an asset of the pension scheme. The policy is held as a contract between the pension scheme and the insurer.
Under a buy-in, the trustees pay a premium to the insurer in exchange for the insurer committing to pay all future payments due from the pension scheme to the members.
The scheme continues to run and to be managed by the trustees.
Unlike the typical assets held by pension schemes, a buy-in policy does more than just generate a modest investment return. It removes risks faced by the pension scheme such as investment risks, inflation risks and longevity risks.
A buy-in also enhances the security of the benefits promised to members.
Insurers are subject to stringent regulations and oversight by the Prudential Regulation Authority and Financial Conduct Authority, and are required to hold prudent reserves so that they can meet the benefit payments due with a very high degree of certainty.
If all scheme members are insured under the buy-in contract this would be described as a 'full buy-in'.
