Insurers eye bulk annuity boost after budget blow

Tue May 6, 2014 3:00am EDT

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* New players set to enter bulk annuity market

* Biggest deal to date was 3 billion pound buy-in in March

* Standard Life's annuity sales fall 50 percent since budget

By Jemima Kelly

LONDON, May 6 (Reuters) - Insurers hit by a UK government shake-up of pension rules are set to make up some of their lost business by ramping up the number of retirement deals they sell to companies rather than individuals.

The industry was dealt a surprise blow in the March budget after retirees with pensions reliant on financial market returns, so-called defined contribution schemes, were told that from April 2015 they would no longer have to buy an annuity, or income for life, at retirement.

For insurers with a big annuity business, such as Resolution and Legal & General, this raised fears of a slide in profits. Resolution's shares have plunged 15 percent since the budget and those of L&G, which last year generated 29 percent of cash flow from its retirement division, 8 percent.

The full impact will not be known until the changes come into force, though Standard Life said last Wednesday that sales of annuities, which accounted for 6 percent of the group's operating profit in 2013, had already fallen by 50 percent in the weeks following the budget.

But the blow could be softened by demand from defined benefit - or final salary - pension schemes, many of which are seeking to hive off their exposure to the risk that scheme members live longer than expected or that interest rates rise, in so-called "bulk-annuity" deals.

The Pension Protection Fund reckons total liabilities in UK final salary schemes top 1.2 trillion pounds ($2 trillion), almost the size of the UK economy.

This year has already seen a record-breaking 3 billion pound deal between L&G and now defunct chemicals firm ICI..

"You're going to have to sell quite a lot of individual annuities to make that kind of money," said Martin Membery, head of insurance at law firm Sidley Austin. "So you can see why these types of deals could be almost a direct replacement for what they're otherwise losing."

While companies can write a derivative contract to remove their exposure to the old-age concern in a so-called longevity swap, insurers will be hoping they opt for the bulk annuity deals, which are more profitable and give the insurer all the assets upfront to invest.

In such deals, the pension scheme sheds responsibility for paying its members their retirement income, either through a buy-out, where the insurer takes over everything, or a buy-in, where the scheme remains the administrator.

NEW IMPETUS

The demand for bulk annuities is already strong, with a record 7.5 billion pounds ($12.7 billion) of deals struck in 2013.

While the first bulk annuity deals were agreed in the 1980s, tougher accounting standards and EU funding requirements, as well an increasing number of final salary schemes closing, have combined to drive up demand from pension schemes.

Consultant Hymans Robertson expects at least 20 billion pounds of bulk annuities to be written in 2014 and more than that next year. 18 FTSE 100 firms have taken part in such pension scheme risk transfer deals, and the consultancy expects that number to increase to 50 by 2017.

If that's right, Membery said, there will be a "massive amount of activity" over the next few years. He also pointed out, though, that the market is finite - with final salary schemes being phased out, bulk annuity deals can only live as long as their members.

So far the bulk annuity market has been dominated by a handful of players - last year just eight insurers wrote 186 deals - but that could be set to change.

"Besides those insurers which already operate... we also expect there to be a number of new entrants to the bulk annuity market," said Sadie Hayes, transaction specialist at consultant Towers Watson.

That extra competition will bring its own pressures, though.

"In my mind it's absolutely clear that, in the short and medium term, the impact of the budget will be to reduce bulk annuity pricing," said James Mullins, a partner at Hymans Robertson, citing an insurer currently finalising a "good-sized" deal that lowered its offer price by 3 percent after the budget.

But L&G, which wrote 1.3 billion pounds of bulk annuity deals in 2013, said high demand from pension schemes for buy-ins and buy-outs would keep pricing high.

"I don't think it (the budget) is causing any margin pressure," said Tom Ground, L&G's head of bulk annuities.

"We're expecting to see certainly good margins, if not improving margins, on the bulk side given the number of opportunities coming to the market." ($1 = 0.5919 British Pounds) (Editing by Simon Jessop and Elaine Hardcastle)

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