The triple whammy of increasing longevity, changing corporate accounting disclosure requirements and greater regulatory emphasis on risk management created the perfect conditions for a pensions buyout market in 2006.
In response, a number of established and new insurers are making a pitch for the liabilities and assets of defined benefit (DB) pension schemes. They include Prudential and Legal & General - the duopoly that has hitherto dominated the bulk annuity buyout market - AIG Life, Norwich Union, Canada Life, Scottish Equitable and Aegon, together with newcomers such as Synesis Life, Paternoster, Pension Insurance Corporation, Lucida and Rothesay Life, the pensions buyout vehicle created by Goldman Sachs.
Of these, Paternoster, headed by former Prudential executive Mark Wood, has made most of the running, winning business from 21 pension schemes since it was launched last year. By the end of June, assets transferred to Paternoster totalled £336m (€496m).
Market conditions in 2007 have provided further impetus, as higher bond yields have shrunk pension fund deficits. Consulting actuary Lane Clark and Peacock (LCP) has estimated that aggregate buy-out deficits for UK pension schemes of FTSE 100 companies stood at £90bn (€133bn) in July, half of last year's level.
LCP reckons that the average funding level for FTSE 100 companies on buy-out is now 80%, with some companies at 100%, making full or partial buyouts an affordable option for some.
Yet interest in buy-outs has been slow to materialise. A survey by Aon Consulting earlier this year of 150 UK companies operating DB schemes found that only one in 10 companies expect to remove their pension scheme liabilities within three years
Paul Belok, head of closed schemes at Aon Consulting, says the findings are in line with their expectations. "The results reinforced our impression that, while there's been a lot of noise and smoke, the reality has been that not that many schemes or employers are currently prepared to pay the additional price to secure benefits in the buyout market.
"That's not to say there won't be some growth in the market, because it's starting from quite a low level.
James Trask, an investment partner at LCP, suggests that the much of the activity is likely to be below the surface. "There are really two buyout markets. The established insurers are looking for traditional full buyout or partial buyout. The new players are competing for larger and more bespoke types of business.
"The process here is a much more long drawn out, involving talking to the company and the trustees about what sort of risk reduction they want to achieve and how they want to go about it. They will be talking about some very complex structures and it may be some time before the deals come through the pipeline."
The chief objection to full buyouts is likely to be the cost. Historically, the yardstick for pension buyout premiums has been 130% of the value of a pension scheme's liabilities under the IAS19 accounting standard. This is significantly more expensive than a liability matching investment strategy. An informal poll of company pension sponsors by Watson Wyatt in March found that only 4% would strike a deal on these terms.
The new players in the pensions buyout market argue that increasing competition or reducing pension scheme deficits could bring these costs down by up to 10%. Changing market conditions can also reduce costs. Pricing analysis by Paternoster shows that over the past two years, the cost to buy out pensions has fallen by 6.5% and the cost to buy out deferred pensioners has fallen by more than 11%, largely as a result of the increased yields on bonds.
Yet pension schemes have cheaper options than buyouts, says Belok. "There have been suggestions of companies being able to sever a link with their pension plan, put the plan into some special purpose vehicle and put some additional funding in, but not to the same extent that would be required if they were to go the insurance market." Much will depend on the attitude of the Pensions Regulator, he adds.
The consultant consensus is that the buyout route is likely to be taken by a minority, albeit a growing minority, of company pension schemes. It remains to be seen whether this will be enough to satisfy the backers of the new entrants in the pensions buyout market.
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