How has the turbulence in the gilts market last week changed schemes’ risk transfer plans and the outlook for buy-ins and buyouts in general?  

 

Skyrocketing gilt yields early last week left defined benefit schemes scrambling for liquidity to shore up collateral pools in their liability-driven investment programmes. In some cases, hedges were reduced, either because the scheme was unable to find liquidity, or because the manager closed the position.

    
The effect of this was that such schemes were more exposed to funding losses when yields fell back following intervention by the Bank of England. So will there be a knock-on effect on buy-ins and buyouts? 
 

 

The impact of the events between 23 and 28 September varies from scheme to scheme. Those that were underhedged may have seen their buyout position improve, while schemes that were fully hedged and have been able to maintain this would have been broadly neutral, said Tiziana Perrella, a professional trustee at Dalriada Trustees. 

 

There are schemes that have fared particularly poorly, however. One investment manager partially removed hedging on Tuesday morning when yields were high, to then partly reinstate it in the afternoon after the Bank of England’s gilts purchase policy announcement, with yields about 75 basis points lower, Perrella recalled. 

“This meant crystallising investment losses, the quantum of which is still unclear for a lot of schemes,” she said. 

 

Similar losses were incurred by schemes selling assets at depressed prices to meet collateral calls under time pressure which could have a long-term negative impact. 

 

One scheme that was due to complete a bulk annuity transaction this week can no longer afford this after incurring both a financial hit and losing hedging, Perrella said. 

She was critical of how the crisis was handled by some managers: “The lack of support and answers from the [investment manager], even just to help us understand the position we find ourselves in, has been disappointing to say the least.”  

 

 

While some schemes have seen their plans scuppered by the events of late September, overall, higher yields are likely to further improve schemes’ funding levels, bringing them closer to a buy-in or buyout. 

 

“The flipside to this is that the high level of demand means that insurers can afford to be selective in respect of the processes they agree to participate in,” she noted.  

 

Consultancy LCP also highlighted the growing competitive tension from recent yield rises, noting that schemes that have already transacted a buy-in will be on the front foot compared with those that are yet to make their first transactions with typical lead times of about six months. 

 

LCP partner Charlie Finch predicted a “bonanza for derisking markets next year” if capital markets stabilise at current levels. “Pricing looks more attractive, it’s been looking very attractive already,” he said. Despite this, he warned against “a knee-jerk reaction” as most schemes have much work to do ahead of approaching insurers. 

 

Whether derisking terms will stay as favourable as they are now is uncertain, however. If demand for risk transfers goes up and insurers come close to reaching their annual capacity of £40bn to £50bn, pricing may well change, admitted Finch. 

 

The sector could also feel the effects of potential regulatory tightening in the reinsurance market, after the Prudential Regulation Authority recently raised the prospect of placing limits on asset-backed reinsurance. "Asset-backed reinsurance is something insurers have been using to scale up capacity. If there is a crackdown that may limit capacity,” he observed. 

 

   

 

Insurers are starting to become selective, having been inundated with requests since the start of the second half of this year, agreed Stephen Purves, head of risk settlement at XPS Pensions Group.  

 

“However, as gilt yields increase transaction sizes reduce. Insurers have a real challenge on their hands if they want to meet volume targets,” he said at a webinar by XPS on Monday. Insurers’ transaction teams will have to work harder, taking on more schemes to fill the same volume: “It's the people side in actually getting transactions through." 

 

Finch said there are staffing “bottlenecks” both in insurers’ quotation and pricing teams and in the consultancy sector, but the area where shortages and workload are most acute is administration. The sector has been inundated with correction work such as guaranteed minimum pension equalisation, while having to digitise data for pensions dashboards. “Buyouts can require a lot of admin resource... It’s actually quite a big concern,” he said. 

 

  

The recent collateral crisis in LDI means there will be some live partial buy-in processes yet to transact where the scheme’s liquid assets buffer will have reduced “to uncomfortable levels” where the transaction will be postponed, said Costas Yiasoumi, a senior director in the pensions derisking team at consultancy WTW.  

 

In other cases, schemes that have been working towards a partial buy-in in the next few years could be putting this off another few years to make sure they retain extra liquidity.   

 

Despite these effects, schemes that were aiming for buyout continue to do so, he said, which means the risk transfer market will remain busy.

“For every scheme that postpones a transaction there will be another scheme that finds it can bring a transaction forward. This close to year-end, if some deals are paused there may be pricing opportunities for other schemes who can act quickly,” he said.