Over the past decade, the bulk purchase annuity (BPA) market has become almost unrecognisable, with its size, sophistication, and efficiency all evolving significantly. Here Suanne Chong and Andrew Kenyon of NatWest Markets preview their session at Life Conference 2023.
There are nine insurers currently known to be actively quoting in the BPA market (with several others rumoured to be looking closely at the space). Having already evolved from the merger or acquisition of smaller players, or expanded from more traditional individual annuity businesses, total balance sheet size has grown substantially, while records for individual transaction sizes have been frequently shattered.
As we will see, evolution of pension scheme funding levels combined with the potential for other third-party capital providers to help support transactions has seen talk of ‘mega’ deals dominate much of the market chatter during the first part of 2023.
This growth in balance sheet size also prompted rapid improvements in capabilities during 2016 to 2018. Alongside increased familiarity with the new Solvency II rules, the growth of smaller firms improved access to capital through the debt capital markets (helping to fund new business and improve returns), while at the same time giving firms the scale to build greater investment capabilities, optimise capital models, and gain access to a much wider range of asset classes with which to back annuity cash out flows.
More recently, soaring interest rates, and the aftermath of autumn 2022’s so-called ‘gilts crisis’, has seen the funding positions of some schemes evolve much more quickly than previously expected, bringing with it pent-up demand for buy-ins and buy-outs.
As well as strengthening funding positions, the same interest rate dynamics have helped many insurers improve their solvency coverage ratios. Discounting effects on firms’ solvency capital requirements (SCRs) have seen ratios move away from the 160% to 180% range that was typical only a few years ago, to levels that are, in some cases, well above 300%.
As well as increasing the budget for capital available to invest into new business, others have also taken the opportunity to improve overall capital quality – reducing leverage and replacing lower quality ‘hybrid’ tier 2 capital with perpetual restricted tier 1 instruments – or to increase distributions to owners.
Reforms to the UK’s solvency rules (imaginatively named ‘Solvency UK’) will see some cuts to reserving requirements – in particular through recalibration of the so-called ‘risk margin’, touted for the end of 2023 – which may also help support elevated levels of solvency coverage.
And, as balance sheets have grown, the volume of capital being released from the in-force book each year has increased. This ‘self-sufficient’ dynamic now sees some BPA providers able to write significant quantities of new business without even needing to tap into this additional surplus, let alone calling on further external sources of capital.
Typically, though, the outlook for the market is less straightforward than it seems. Many of the schemes that have reached a funding position suitable for buy-out more rapidly than expected have not yet had the chance to rebalance their investment portfolio to one that would be suitable for transfer to an insurer. Indeed, certain illiquid exposures – many due to mature in the period between now and the originally expected timeline of their journey to buy-out – are creating significant challenges for the BPA market.
Some sponsors, having seen deficits close rapidly, are also starting to ask whether it may be more efficient for them to continue running their schemes off in a low-risk way, rather than paying a premium to an insurer to take the liabilities off their hands.
There could also be regulatory headwinds ahead: Solvency UK may create some additional investment freedom for annuity writers, but it also looks set to increase the burden on firms to, for example, attest that they are holding suitable reserves to cover against default (and other asset) risks, as well as any cash flow mismatches.
Increasingly, funded reinsurance (effectively, variations on more traditional ‘quota share’ reinsurance for annuities) had become another important source of capital for the industry – allowing external capital providers to help to support transaction volumes – and a helpful tool for de-risking investment returns, at prices that appeared to be extremely favourable for the UK BPA writers.
With many of these providers based in Bermuda, this part of the market potentially faces a double-whammy of regulatory scrutiny from both the Prudential Regulation Authority (who is concerned about whether counterparty exposures and collateral terms are being appropriately managed) and the Bermuda Monetary Authority (who has come under pressure recently to clarify its expectations with regards to some of the reserving principles and capital requirements underpinning its own regime).
And, finally, the existence of ever-larger deals in the pipeline raises the question of potential diseconomies of scale. Finding opportunities to invest potentially tens-of-billions of pounds of premiums will be exceptionally challenging – not least given challenges finding long-dated borrowers in a higher interest rate environment. Investing overseas will increase hedging requirements and put further pressure on pools of collateral available to collateralise such arrangements.
This, and other synthetic hedging needs (for example, management of inflation risk using derivatives), may start to push markets to their capacity in terms of ability to absorb risk. Further, parties may be exposed to ever-greater quanta of risk during the pricing phase of a transaction, given the potential for market moves between pricing and execution phases.
Can these challenges be overcome, or might we find participants longing for a return to a slightly slower pace of life…?
Andrew and Suanne will present ‘UK bulk annuity market: bigger, stronger, faster, harder’ at Life Conference 2023.
Come and find out more in workshop C1 on Thursday 23 November at 15:10.
Learn more and book your place
