The rapid improvement in defined benefit pension scheme funding levels over the space of last year is extraordinary. According the Purple Book, surpluses in 2023 were £367bn, an increase of more than £110bn from 2022.
With buy-out transfers expected to be around £50bn a year from pension schemes to insurance companies, asset managers will need to re-assess what products and services they will be able to offer, if they want make the most of this asset transition.
At first glance, it might seem like there asset managers have more opportunities with insurance companies. They have a more diversified portfolio. Insurers invest only up to 30% of the portfolio in gilts compared to 70% for a closed DB scheme. Corporate bonds make between 25% to 55% of an insurer’s portfolio.
In-house capability
But it can be difficult for asset managers to get a foot in the door as insurers manage many of their assets in-house. The scale of the asset transfer may, however, throw up some opportunities.
Investing £50bn a year is not going to be straightforward. While insurers tend to prefer the UK corporate debt market, it may not be possible to find sufficient liquidity and insurers will instead need to look to global markets. If an asset manager has more expertise in this field, they may be able to help.
The other possible avenue is to offer insurers access to asset classes where they lack in-house expertise. Sustainable investment strategies might be one such area as many insurers have eye-catching net zero targets such as halving emissions by 2030 to reach net zero by 2050.
Matching adjustments
But perhaps the biggest impediment to schemes being able to win mandates from insurers’ annuity business are regulatory restraints.
Not only does Solvency II penalise riskier asset classes with hefty capital charges but fixed income investments also need to be ‘bounded’. This means the debt cannot be re-paid in advance and the income stream needs to be predictable.
Even more onerous than this is designing a sustainable fixed income investment strategy which are matching adjustment compatible.
This allows insurance companies to take upfront credit for investment returns that will take decades to be realised.
For long-dated obligations such as pension payments, its impact can be vast and extremely beneficial. The capital of an insurer’s annuity and life businesses would be much less healthy without the impact of the matching adjustment.
If an asset manager wants a piece of these buy-out flows, it will need to develop a fixed income sustainable investment strategy which meets bounded capital and matching adjustment requirements.
Some asset managers are starting to think about how investments can be structured to meet these requirements.
There is, however, an alternative. Even with a transfer of £50bn a year, it will many years for schemes to transfer across their assets and some schemes now may opt for self-sufficiency over the long-term. A later blog post will discuss the options available for asset managers with these schemes.
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