After a slow start, 2021 proved another strong year for insurance and reinsurance transactions de-risking the liabilities of DB pension schemes. Market views on the exact volumes of business written vary, and some transactions – particularly longevity swaps – may not be publicly announced. However, the consensus suggests that at least £27.7bn in buy-in and buy-out policies were written, with a further £15.5bn in longevity swaps, making 2021 the third busiest year ever by aggregate volume after 2019 and 2020.
Competition amongst the UK life insurers who target the bulk annuity market remained healthy. Although a lower number of £1bn+ transactions may have slightly reduced overall market share for insurers such as Legal & General, Pension Insurance Corporation and Rothesay compared with previous years, a steady stream of smaller and mid-sized transactions drove record bulk annuity volumes for Aviva, Canada Life and Just Group. Phoenix/Standard Life also had a record year, writing £5.5bn in transactions, including the second and third largest transactions of the year (a £1.8bn buy-in with the Imperial Tobacco scheme and a £1.7bn buy-in with the Gallaher scheme), as their investment in this area of the market began to bear fruit.
With current private sector DB liabilities exceeding £2 trillion and less than 30% of DB pension schemes in the UK with assets over £1bn having yet taken out any form of de-risking insurance, the market opportunity remains substantial, particularly if (re)insurers are able to continue to find asset opportunities – something that the upcoming Solvency II reforms may help – and keep pricing competitive. Indeed, consultants Hymans Robertson recently suggested that a further £650bn in liabilities might be insured by 2031. However, an expanding de-risking market may also present opportunities for non-life specialty insurers as well as the life (re)insurers underwriting the core liabilities of schemes.
A key consideration for trustees who are looking to execute a full scheme buy-out and then wind-up their scheme has always been how to address any residual liabilities that are not covered by the buy-in/buy-out policy and might result in future claims against the trustees. Indemnities from a sponsoring employer may provide some cover, but they will not respond in all situations. Their value is also dependent on the financial strength of the sponsor itself.
The traditional solution for this has been pension trustee liability (PTL) run-off cover, indemnity policies specifically designed for schemes that were in the process of being, or had been, wound up. These are designed to cover any third-party claims alleging financial loss, typically for periods of between 6 and 15 years (tying in with the “long stop” time period for most legal claims under the UK’s Limitation Act 1980). They can also be structured so that they expressly cover any missing beneficiaries who were not insured under the buy-in/buy-out policy and make themselves known after the scheme assets have been distributed.
PTL run-off cover, however, has never been a perfect solution from a trustee perspective. This is particularly the case for larger schemes, where purchasing a sufficient level of cover may be expensive (current premiums typically seem to fall in the region of 2.5% of the level of cover sought) or indeed impossible over a certain value due to restricted market capacity. Schemes with a more complex history and benefit structure may also face challenges in demonstrating the adequacy of members’ benefit entitlements, with a knock-on effect on pricing. This has been exacerbated by a market that, at least anecdotally, has hardened in recent years. At the same time, trustees may have concerns about what this type of cover may mean in practice for members: while the policy may provide comfort for the trustees, particularly as regards any future legal costs, establishing a claim that the trustees have acted wrongfully may represent a significant hurdle for a member trying to get paid the right benefits.
One product that has developed over the past decade to try to fill this gap has been residual risks (or “all risks”) cover. This is provided by the primary life insurer as an add-on to the main bulk annuity contract and is specifically designed to cover errors in the benefits payable to scheme beneficiaries, for example due to errors in the scheme’s data, historical misadministration, or because a beneficiary was not recorded in the scheme’s records at all at the point of buy-out. Residual risks policies have a number of key advantages for trustees: there is usually no time limit in which claims must be brought, providing comfort that missing beneficiaries who turn up in 20 years will still have the chance to get their benefits; and cover is usually uncapped, providing comfort that a few early claims will not burn through the cover. The structure of the policies also means that (former) members engage directly with the insurer, keeping the trustee out of the picture and avoiding the need for the claimant to prove any breach of trust, with the reduced reputational risk that this entails.
The appetite for residual risks cover has increased significantly over recent years, with anecdotal evidence suggesting that around three-quarters of schemes with liabilities over £500m opt to purchase this additional cover and around half of schemes between £200m to £500m. However, they can be an expensive option for schemes, with premiums typically equating to around 0.5% of the overall premium for the bulk annuity policy, while cover for smaller schemes (sub £200m) is limited. This may reflect the fact that assessing the types of risk involved in residual risks cover is not really within the core competency of life insurers, who typically offer it mainly as a way of securing the main transaction.
This in turn suggests that there may be opportunities for specialty insurers to develop new products that help fill gaps in the current market. Bespoke, standalone residual risks policies, for example, could potentially help smaller schemes that want to move to a full buy-out but are not able to secure affordable residual risks cover from a life insurer. Life insurers, on the other hand, may see value in being able to take out insurance that covers at least some proportion of their underlying residual risks liability – we advised one UK life insurer on a bespoke indemnity-type policy that achieved this result last year. If, as predicted, the volume of schemes entering into buy-out transactions continues to grow, demand for these types of innovative, alternative solutions can only increase.
This article originally appeared in Insurance Day on 6th April 2022.
Authored by Jonathan Russell.
