Trustees of fully funded pension schemes may find themselves at the back of a queue they did not know existed – and which is only getting longer, Axa Investment Managers has warned.
Defined benefit (DB) pension schemes seeking a buyout need to brace themselves for major delays as soaring demand for risk transfers places pressure on an already crowded market.
AXA Investment Managers (AIM) said the rising impact of gilt yields on pensions which had pushed up DB schemes' surpluses had pushed forward the average time for a scheme to be fully funded to just over five years.
CitingBarnett Waddingham’s DB End Gauge tracker AIM added that at least a quarter of schemes were now fully fundedon a buyout basis, with anecdotal evidence suggesting it could be far higher following the gilt pricing issues after the Liz Truss mini budget spike.
Lionel Pernias, head of fixed income investment solutions at AIM, said there was now a mismatch between supply and demand for full risk transfers.
He said: "Forecasts suggest that record numbers of risk transfers will be completed in the coming years as more schemes become fully funded on a buyout basis, but the market has limited capacity."
Pernias pointed out there were just eight insurers in the market. “Trustees have been told for a long time that a buyout is contingent on their funding status and little else, but the reality now is there is an unprecedented supply crunch, which means they could find themselves at the back of a queue that they didn’t know existed – and which is only getting longer.”
Insurers, pension schemes and the supply crunch
Pernias said there was a supply crunch as insurers faced two main issues - a lack of capital and difficulties sourcing suitable assets.
“Insurers need capital to underwrite deals to meet their solvency ratios and they only have so much of it – the assets they will receive from pension schemes will not cover it,” he says.
“The other prominent issue is the lack of sourcing suitable assets. Insurers need to put their capital to work in high-quality public and private debt markets to ensure that cash flows match the liabilities under the matching adjustment framework. But there is a limited number of these assets and a shallow supply pipeline given the end of the unwind of the Bank of England’s corporate bond purchase programme."
To make matters worse, there are fewer issuers coming to the GBP market with insurer-friendly new supply in 2023. If insurers cannot source those assets, they will not be able to underwrite the deal.”
Plan B for schemes
Pension schemes will face their own issues, not least cleaning member data, and more aggressive pricing from insurers as they manage elevated demand.
Beating the buyout backlog
Schemes need to remain buyout friendly, so maintaining the desired funding ratio and putting any surplus to work. AIM claims investing in credit may be one solution.
Pernias said: “In our view, the most effective way they can achieve this is by allocating to credit through cashflow driven investment strategies, which can offer good liquidity, attractive return potential, stable and timely cashflows that could appeal to insurers in future, and ideally a climate-integrated approach that would help differentiate them in a competitive market where ESG risks and commitments are increasingly central.
"Credit is also a much better place to be if there is a more severe economic downturn than expected, as funding levels are not calculated on a corporate bond basis.
“It is clear that the buyout market has changed. Today, schemes simply cannot afford to sit on cash for unknown years while they wait to achieve a full risk transfer. Trustees must prepare themselves for a longer wait now.”
