Grant Thornton - Pensions de-risking market quarterly update: Q4 2012
De-risking market quarterlyupdate: Q4 2012Welcome to our quarterly update on the latest developments in the definedbenefit (DB) pension plan de-risking market. We will be looking at all aspects ofthe market, including regulatory developments, product development, completedtransactions, product pricing and market sentiments. We will also provide viewson the future development and shape of the market. This continues to be an extremely interesting and dynamic time in the de-risking market, with activitycontinuing to be strong despite gloomier predictions over the time it will take for the economy torecover. In this update, we look at the last three months of 2012, including providing a background to somepertinent regulatory issues, the drivers behind recent de-risking activities, some innovative de-riskingsolutions that we can advise on and a preview of how we think the market will develop in the next six totwelve months. The overall effect will depend on the optionRegulatory issues in the market chosen and benefit structure of the pensionRPI averaging method schemeOn 8 October 2012, the Office for National 3) CPI-linked benefits will not change on an on-Statistics (ONS) announced a consultation about going basis. However, insurers do notthe method used to calculate the Retail Price Index currently have a large market in which to(RPI). There are two key reasons RPI is expected purchase CPI-linked assets, so often use RPI-to be consistently above the Consumer Price Index linked assets as a proxy, which will be cheaper(CPI). One is the underlying basket of goods and . Thus, this change could lower the costs ofthe other is the method used to calculate the de-risking CPI-linked liabilities.average price. CPI uses a geometric average andRPI uses an arithmetic average, which has anupward bias of around 0.5% to 1% pa. Theconsultation proposed various options on how toreduce or remove this inconsistency. The results ofthe consultancy will be announced in January 2013,with anticipated implementation in March 2013. The impact of this change is dependent onwhether a pension schemes revaluations are in linewith CPI or RPI. Depending on the optionimplemented, RPI expectations could falldramatically. This will have three effects:1) Index-linked gilts are based on RPI, so any fall in RPI expectations will be reflected by a fall in the value of any index-linked gilts2) Any scheme with RPI revaluations will experience a significant reduction in liabilities.
Market sentiment evidence to suggest that the market respondsInvestors and equity analysts are increasingly positively to companies that have implemented ataking into account the risk management strategies materially significant risk reduction strategy onof companies with DB pension funds. There is their pension plan. See the table below for some examples. Share price % TransactionCompany Date Type of de-risking Before After change sizeAkzo Nobel May 2012 Longevity swap £1,400 million 40.69 40.93 0.6 BPATate & Lyle December 2012 £350 million 756.5 769 1.7 BPACookson July 2012 £320 million 607.5 633.5 4.3 BPAGeneral Motors December 2012 £230 million 25.63 25.56 -0.3 BPAAon Minet July 2012 £100 million 46.43 46.81 0.8 "A small risk premium is payable and the "As the market edges lower, Tate & Lyle has accounting deficit will increase slightly as a bucked the trend after the group unveiled a result. But this feels like good business to us" pensions deal with Legal & General" Investec commentary The Guardian commentary on Tate & Lyles buy-in, 10 December 2012 on Tate & Lyles buy-in, 7 December 2012Outlook for the next 12 months such as Swiss Re and L&G. Activity in the marketBulk purchase annuities has slowed due to this turnover in marketWith many analysts expecting further Quantitive providers and only two major deals were signed inEasing in 2013 and predictions of an increasingly 2012, both with Swiss Re.slow economic recovery, it seems unlikely that we In a Solvency II framework, initial capitalwill see any significant upwards movement in gilt requirements are significantly lower for a longevityyields. Assuming that this low gilt yield is sustained swap than a BPA structure, a feature that weover the upcoming year, we expect that most BPA expect to attract more insurers into the market.contracts will be related to pension plans cashing However, as longevity swaps often take some timein on historic good performance of certain asset to execute, it is possible that deals involving theseclasses, such as bonds or deferred premium insurers may not complete until the latter half ofarrangements for those pension plans who need to 2013.rely on a medium-term pick-up in the equity We also expect more plans to use a combinationmarket. of solutions to tackle the different risks they face. Combining a pensioner buy-in and a non-retiredLongevity swap market index-based longevity swap with a liability-drivenThere was a rush of activity at the end of 2011, a investment (LDI) overlay can lead to a de-riskedyear where around £7bn worth of longevity swaps position that is very close to a buy-out - a ‘DIYwas written. In the first half of the year many buy-out’, where the index-based longevity swapbanks, such as Deutsche Bank, UBS and Nomura would have to be re-executed at the end of eachpulled out of the market, to be replaced by insurers contract term, usually every 15 years.
De-risking transactions in the last yearThe bulk purchase annuity deals struck in the last 12 months with a premium in excess of £100m arelisted below:Date Pension scheme Counterparty ValueDecember 2012 Merchant Navy Officers Pension Fund Rothesay £680mDecember 2012 Tate & Lyle Group Pension Scheme Legal & General £350mJuly 2012 Cookson Group Pension Plan PIC £320m West Midlands Integrated TransportApril 2012 Prudential £270m Authority Pension FundDecember 2012 General Motors UK Pension Plan Rothesay £230mMay 2012 Gartmore Pension Scheme PIC £160mJuly 2012 Aon Minet Pension Scheme PIC £100mTotal £2,610mThe major longevity swap deals struck over the past 12 months Structure: (indemnityDate Pension scheme Counterparty Value or index-based)May 2012 Akzo Nobel (CPS) Pension Swiss Re Indemnity £1,400m SchemeDecember 2012 LV= Employee Pension Swiss Re Indemnity £800m SchemeTotal £2,200mInnovation out or mitigate the risks faced by your pensionWhile a pension annuity buy-in remains the most scheme. Our work can help both privately-ownedpopular insurance-based solution used to de-risk a and listed corporate sponsors and trustees todefined benefit pension fund, Grant Thornton reduce the risk of financial losses as a result of thecan advise on a wide range of new and creative pension scheme and concurrently give morede-risking solutions, which are tailored to the size, protection for members accrued benefits.risks and requirements of an individual pension We also play an important role in providingscheme. pensions advice in corporate Mergers & We offer independent advice on structured Acquisitions transactions.solutions and transactions that will either transfer
De-risking market quarterly update: Q4 2012 January 2013Key contactsDarren Mason Kelvin Wilson James EdelmanHead of Pensions Director, DB Pensions Assistant Manager, DB PensionsT +44 (0) 20 7728 2433 T +44 (0) 20 7865 2402 T +44 (0)20 7865 2819M +44 (0) 7971 434 964 M +44 (0) 7879 667 208 M +44 (0)7780 687650E firstname.lastname@example.org E email@example.com E firstname.lastname@example.orgDarren has over 20 years Kelvin advises on bulk purchase James is a part qualified actuaryexperience in corporate annuities, longevity swaps, with an MA from Cambridgetransactions and restructuring. investment strategy (including University and an MSc fromHe has led over 100 assignments liability driven investment Imperial College Business School.flowing from the new legislation strategies) and designing and He has worked with a number ofgoverning the stronger funding of implementing flight paths for corporates and trustees in the pastdefined benefit schemes looking to achieve a on SSF valuation calculations andpension schemes advising on the target funding objective. negotiations, M&A activity, riskimpact for trustees, companies Whilst at Prudential M&G, Kelvin analyses and implementing de-funding the schemes and their helped structure the first £1bn risking solutions.lenders. pension annuity buy-in with Cable He now specialises in advisingAssignments have included & Wireless Superannuation on pension scheme risks and howchanges in covenant as the result Pension Scheme. to manage these risks over theof a transaction, clearance Kelvin holds an MA from Oxford long term.applications, employer covenant University and has an actuarialin SSF valuations, contingent and investment managementasset solutions, covenant background. He has performed,monitoring and restructuring reviewed and analysed a numberinvolving scheme sponsors. of valuations. He recently advisedMany of these assignments have a purchaser about the appropriateincluded groups with overseas level of price adjustment neededownership including listed on a deal involving a definedcompanies in the US, France, benefit pension scheme.Germany, Malaysia, Japan andAustralia. 1
De-risking market quarterly update: Q4 2012 January 2013About Grant ThorntonGrant Thornton UK LLP is a leading financial and business adviser, operating out of 28 offices. Led by215 partners and employing nearly 4,000 of the professions brightest minds, we provide personalisedassurance, tax and specialist advisory services to over 40,000 individuals, privately-held businesses andpublic interest entities. As a member of Grant Thornton International Ltd, we are one of the worlds leading internationalorganisations of independently-owned and managed accounting and consulting firms. Our deep-rootedexperience in the issues affecting mid-sized businesses, combined with the true global reach and resourcesof Grant Thornton International Ltd, means that were uniquely placed to deliver the best advice, in aseamless way - regardless of service line, regardless of location. Clients of member and correspondent firmscan access the knowledge and experience of over 2,500 partners in over 100 countries and consistentlyreceive a distinctive, high-quality and personalised service wherever they choose to do business.About Pensions AdvisoryPensions Advisory offer independent advice on structured solutions and transactions that will eithertransfer out or mitigate the risks faced by your pension scheme. We can advise on a wide range of new andcreative de-risking solutions, which are tailored to the size, risks and requirements of an individual pensionscheme. Our work can help both privately-owned and listed corporate sponsors and trustees to reduce the risk offinancial losses as a result of the pension scheme and concurrently give more protection for membersaccrued benefits. We also play an important role in providing pensions advice in corporate Mergers &Acquisitions. 2