Buy-in pricing could improve in post-Brexit world

Over the past year, worries about the impact of Brexit have continued to fuel withdrawals from UK property funds, taking outflows to £1.2bn, and £4bn has also been wiped out of UK equity funds, according to the latest Investment Association figures.

While there is an obvious risk of assets such as UK equities being negatively impacted, equally, schemes could see opportunities around buy-in pricing following Brexit.

For those funds that are ready and are able to move quickly, this means there could be some opportunities to derisk liabilities, in what could otherwise be seen as a disruptive period.  

If sterling falls again it can make it easier for US sponsors to plug deficit gaps if they aren’t hedged for currency risks

Sammy Cooper-Smith, Rothesay Life

Post-Brexit volatility poses opportunities

Long-term interest rates, future inflation expectations and credit spreads are all expected to respond to the particular Brexit Britain chooses, explained Richard Wellard, partner at Hymans Robertson.

“These market indicators all impact buy-in pricing and how attractive that pricing appears to pension schemes,” he said.

As prices move around, DB schemes that are ready to go – and which have the correct governance in place – could see opportunities to transact, said Sammy Cooper-Smith, co-head of business development at Rothesay Life.

“If sterling falls again it can make it easier for US sponsors to plug deficit gaps if they aren’t hedged for currency risks,” he said.

“Likewise, if rates increase, unhedged schemes will see their deficits drop. On the other side, widening spreads could create investment opportunities for insurers.”

All these factors could contribute to making pricing more attractive, and insurance more achievable, for certain DB schemes in a position to transact.

Higher yield leads to cheaper buy-in pricing 

In periods of market turmoil and uncertainty – for example, if there is a move to ‘safe’ assets such as government bonds – the price of corporate bonds or more illiquid cash flow-matching assets can fall.  

The yield on such assets would then increase, and the higher the yield the cheaper the buy-in price. 

For example, a buy-in yield of 0.1 per cent to 0.2 per cent a year below gilt yields might be viewed as a fair price to pay given the reduction in longevity risk, other demographic risks and the level of cash flow-matching achieved, according to data from Hymans Robertson.

Recently, there was an improvement in the combined deficit of UK DB schemes, due to a small rally in gilt yields combined with a slight fall in inflation expectations. However, gilt yields remain at historic lows.

But average pricing compared with gilt yields continues to be attractive, despite hardening slightly since the start of 2019.

Buy-in pricing is strongly linked to credit spreads, and if credit spreads blow-up after the UK leaves the EU – because corporate bonds are seen as riskier in the short term – that potentially enables insurers to pass on reduced pricing, explained Paul Kitson, partner at PwC.

“If corporate bonds are cheap at the point you do the buy-in, then the insurer will expect to make more of a return on them over the life of the buy-in so the buy-in price goes down,” he said.

Because the yield going up may indicate an increased likelihood of default – because the insurer will retain some of this increased yield as capital against default – it is often the case that the price moves more than the default expectation, Mr Kitson added.

This would mean that buy-in is cheaper as a result.

“Indeed, we saw exactly this phenomena in the aftermath of the global financial crisis of 2007 and 2008,” Mr Kitson said.

“Over periods, yields on corporate bonds and other assets went up by more than the increase in the default expectations on those bonds and therefore buy-in pricing [for short periods] fell. Schemes that were ready to trade captured this.”

Changing market requires trustees to be well informed and prepared

Following a record-breaking 2018, the volume of buy-in and buyout transactions completed over the first half of 2019 remained high. 

According to Hymans Robertson, the expected total volume of transactions for 2019 will exceed £30bn for the first time ever.

However, it may not always be the case that periods of uncertainty or turmoil will lead to a fall in buy-in pricing.

“As the saying goes, it depends what sort of leaves fall on the train track as to whether it delays the train,” said Mr Kitson.

Some types of disruption will cause insurers to react in a way that mirrors the market, and so buy-in pricing will stay static or potentially even increase. There are also certainly types of market uncertainties and disruption that will cause buy-in pricing to fall, explained Mr Kitson. 

The trick is for schemes to be prepared. But care must be taken on schemes’ “fishing expeditions”, warned Mr Wellard.

He said: “It is important to remember that an incredibly big driver to buy-in pricing in today’s market is insurer appetite and capacity. Insurers favour execution certainty.”