Insurance companies could raise bulk annuity buyout pricing as deferred members will demand higher capital reserves under Solvency II, consultants warn.

PwC suggested a “worst case scenario” of the cost of a buyout, where the insurance company takes on all liabilities of a defined benefit (DB) pension scheme, rising by 10% in 2016.

However, pensions director and buyout adviser, Jerome Melcer, said this was a rough estimate based on a combination of stringent capital requirements by the UK’s Prudential Regulation Authority (PRA), unfavourable discount rates, and a high average liability duration.

The issue stems from revised capital requirements under Solvency II coming into effect from 2016, meaning all business written in 2015 would be cheaper for insurers, with regulations allowing for a transitional period of 16 years for old liabilities to be covered under the new regime.

However, while insurance companies can perfectly match pensioner liabilities in DB schemes, this is not possible for deferred and younger members where the liability is impossible to determine.

This results in the insurance company needing to hold more capital for such liabilities.

Insurers are currently negotiating with the PRA as to exactly how much capital should be required for each type of liability, based on their own capital and investment structures, with final determinations expected next month.

The resulting system would see different capital requirements imposed on each insurer for the same liabilities based on how these are matched by investments.

Melcer said the 10% was slightly “finger in the air” but that business written in 2016 would certainly be more costly to pension schemes than 2015.

“There will be a range of outcomes depending on the insurer so the extent of cost increases will vary among providers,” he said. “The 10% is based on the insurance companies not adapting to the new environment.”

Hymans Robertson partner James Mullins, said the 10% figure was an exaggeration, but accepted that prices could certainly rise at the start of 2016.

“Insurers have been pricing for Solvency II for some time now. Pricing will change, but not a steep change to [10%],” he said.

Mullins also suggested Solvency II, and the risk of higher pricing early in 2016, would see a boom in business towards the end of this year.

“Some insurers have been quiet [on buyouts] waiting for Solvency II requirements to be signed off, so there could be a rush before it comes into play because of the 16-year rule,” he said.

Charlie Finch, partner at consultancy LCP, also declared the 10% estimate was an over-exaggeration, but again agreed the start of 2016 could be more expensive.

“Insurance companies will work on updating models over time to remove the consequences of new capital requirements.

“Trustees probably shouldn’t buy in January or February but over time the pricing will not make a difference,” he said.

Competition is also expected to impact the buyout market, as new entrants join the bulk annuities market.

Scottish Widows is set to begin tendering for deals this month but will focus on pensioner buy-ins in the short-term, and assess buyouts by mid-2016.

While buyout pricing could rise, insurance buy-ins, where the scheme exchanges assets for an insurance contract, will not as they are easily matched under Solvency II.

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