JLT EMPLOYEE BENEFITS JLT EMPLOYEE BENEFITS. Buyout Market Watch

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1 JLT EMPLOYEE BENEFITS JLT EMPLOYEE BENEFITS Buyout Market Watch An Update Report from JLT Employee Benefits as at 30 June 2013

2 JLT Buyout Market Watch Update 30 June 2013 Executive summary After a healthy end to 2012, business levels written in the first half of 2013 were very encouraging with over 2.0bn of buy-in and buyout deals completed. Coupled with the announcement of the 1.5bn EMI deal in July, the largest buyout to date, there is an optimistic mood for a very successful year with total deals likely to exceed last year s figure of 4.5bn. In addition, there have been two longevity swap deals, worth a combined 3.6bn, including the largest to date between Legal & General and BAE Systems in February News from the market The big deals In July 2013, the EMI Group Pension Fund completed a 1.5bn buyout transaction with PIC, the largest buyout deal to date. Significantly, the transaction covered all risks, including data errors. Also, in early September 2013, Rothesay Life insured 440m of liabilities in respect of the InterContinental Hotels UK Pension Plan in a full buyout transaction. The benefits insured included pension increases previously provided at the sponsor s discretion and data risk, in the form of missing beneficiaries, was also insured. This followed another deal by Rothesay Life, announced in July 2013: a 280m buyin for the Cobham Pension Plan. The largest bulk annuity deals struck over the year ended 30 June 2013 are illustrated in the table below (with deals completed in the last quarter highlighted in blue): Scheme Date Value Insurer Merchant Navy Officers Dec m Rothesay Life Tate & Lyle Q m Legal & General Cookson Jul m PIC Cobham* Jul m Rothesay Life Undisclosed Q m Legal & General General Motors Oct m Rothesay Life Smith & Nephew Q m Rothesay Life First Quench Apr m PIC Undisclosed Q m Prudential Undisclosed Nov m PIC Vestey Group Nov m Rothesay Life Undisclosed Apr m PIC *Transacted in Q2 2013, but announced in July 2013 Longevity solutions There have been two longevity swap deals agreed so far in 2013: The largest longevity swap deal to date, announced in February 2013 between Legal & General and BAE Systems, covering 3.2bn of liabilities; and In May 2013 between the Bentley Pension Scheme and Deutsche Bank, covering 400m of liabilities. The top 10 longevity swap deals struck since 2009 are illustrated in the following table. Scheme Date Value Counterparty BAE Systems Feb bn Legal & General Rolls Royce Nov bn Deutsche Bank / Abbey Life BMW Feb bn Deutsche Bank / Abbey Life RSA Jul bn Rothesay Life ITV Aug bn Credit Suisse Akzo Nobel May bn Swiss Re BA Q bn Rothesay Life Babcock International May bn Credit Suisse Pilkington Superannuation Royal County of Berkshire Dec bn Legal & General Dec bn Swiss Re Insurers are reporting a healthy pipeline of potential deals, some of them at the very large end, which means that expectations are high for the remainder of 2013 in this segment of the market. However, these transactions can be complex and concluding a contract normally takes a number of months. Innovative solutions A market in medically underwritten bulk annuities is fast developing, with several transactions announced in the first half of These initial deals were all written by Partnership Assurance, an enhanced specialist from the individual annuity market, who entered into the bulk annuity market in However, three more insurers: Legal & General; Just Retirement; and Aviva are also able to provide medically underwritten quotations and we expect another deal to be announced within the next few weeks. JLT have developed a common process with all four insurers listed above and are able to offer a whole-of-market medically underwritten bulk annuity broking solution; enabling schemes for the first time to obtain multiple underwritten quotations from a single underwriting process and thus ensure a competitive process. Legal & General completed a buy-in for the Kenwood Pension Scheme, using a deferred premium mechanism to spread the premium payments over a number of years. Members benefits were secured on day one, with the sponsor agreeing a fixed payment schedule with Legal & General. This enabled the sponsor to significantly reduce risk in its scheme with flexibility over meeting the costs of the exercise, and illustrates how insurers are increasingly willing to agree tailormade solutions for schemes serious about de-risking. Buyout Market Watch 2

3 Insurer news Early in August 2013, Legal & General completed its acquisition of Lucida, adding a further 1.4bn of annuity assets to its books. Lucida was a specialist bulk annuity provider which closed for new business last year. Also in August, Goldman Sachs announced they are putting their majority stake in Rothesay Life up for sale. There has been initial interest from Blackstone, a large private equity group. It is understood the decision is due to tighter banking regulations and an opportunity for Goldman Sachs to realise a return on its capital. Rothesay Life remains open for new business. It raised capital earlier this year, and recently announced a 280m buy-in for the Cobham Pension Plan and a 440m buyout for the InterContinental Hotels UK Pension Plan. Smaller deals Although it is often the large deals that hit the headlines, smaller buy-ins continue to dominate the market in terms of numbers of deals written. Generally, these are conventional buy-ins or buyouts, although medically underwritten deals are now possible for schemes with up to about 300 pensioners. Key to ensuring a successful and competitive buy-in or buyout process is to work with an experienced adviser, with a well-established process and a good conversion rate (i.e. a high proportion of deals brought to market actually transact). JLT have developed Buy-inSure, a robust pensioner buy-in solution for schemes wishing to secure between 5m and 60m of pensioner liabilities. Buy-inSure provides a clearly defined process, with condensed transaction times. The first case to be transacted was a buy-in of circa 8m, completed in July The client received quotes from three insurers and was able to transact within just six weeks of data extract; much quicker than a traditional broking approach which could take in excess of six months. JLT s conversion rate, recently measured at 64% by one insurer over a period up to July 2013, is significantly ahead of the market average of around 20%. Capturing opportunities With many insurers now providing sample annuity rates, indicative buy-in prices are proving more accessible. As such, schemes should consider undertaking a feasibility study to discover whether a full broking exercise could be beneficial and would be likely lead to an affordable transaction or not. Insurers pricing bases have remained relatively stable during the year; however, with volatile gilt and bond yields, the timing of any transaction is crucial. Schemes with the right liability profile may still be able to obtain a quotation at or around gilt prices; hence may be able to swap their gilt holdings for a buy-in at little or no additional funding cost. The strategic value of this, including removal of longevity, investment and inflation risks, should not be underestimated. Future capacity Rising gilt and corporate bond yields, improvements in equity markets and a pickup in the wider developed market economy have led to a healthy number of deals transacted so far in We expect business levels to be up from the 4.5bn of buy-in and buyout deals written in Insurers have indicated that they have more capital to write deals to the end of 2013 and beyond. However, we anticipate that, if conditions continue to improve, insurers will become increasingly selective about the business they quote for. Once again, appointing an adviser with an established process and high conversion rate will put schemes at an advantage when attempting to run a competitive buy-in or buyout process. JLT Buyout Affordability Index Some of the most recent developments affecting the price and attractiveness of a bulk annuity solution or longevity swap are considered below and overleaf Regulations Tougher capital requirements under Basel III have resulted in some banks withdrawing from the buyout and longevity swap markets. Goldman Sachs announced in August 2013 that it is planning to sell a majority stake in Rothesay Life and has had some initial interest from Blackstone, a private equity group, who are subject to lighter regulation. This follows Credit Suisse s move last year to wind down its longevity swap business and decisions by UBS and Nomura not to enter the market. Basel III demands relatively high capital on long-dated swaps, such as those used to hedge pension liabilities, e.g. longevity swaps typically extend for up to 50 years. The withdrawal of banks from the market potentially provides more opportunities for insurers, for whom longdated pension risks are part of core business. Uncertainty still remains over the Solvency II regime to be introduced for insurers, but this has been postponed for the foreseeable future. Michel Barnier, the European Commissioner, has announced that he will not introduce Solvency II capital requirements for defined benefit pension funds in the revised version of the Directive on Institutions for Occupational Retirement Provision (IORP) to be published in the autumn. The postponement has been welcomed by the pensions industry and the UK Government as it has been estimated that the introduction of Solvency II rules would have pushed up UK defined benefit liabilities by in excess of 400bn. Whilst more onerous capital requirements would have further increased the pressure on companies to de-risk and insure their defined benefit pension liabilities, we are nevertheless seeing increasing interest from corporate sponsors as they begin to appreciate the full extent of the risks they are exposed to through their defined benefit pension schemes. Pensions Minister Steve Webb has said that there will be no new government announcements on equalisation of Guaranteed Minimum Pensions (GMPs) until spring There was widespread criticism from the pensions industry that the Department for Work and Pension s draft method for equalising GMPs contained in a consultation in January 2012 was too costly and complex. In the meantime, schemes in the process of winding up are adopting methods that they deem to be actuarially justifiable. Unless the final regulations are considerably more onerous, we do not anticipate that they will impact the buyout market in any significant way. Buyout Market Watch 3

4 1/03/201331/03/201231/03/201131/03/201031/03/200931/03/ //0/0/0/0/0/0/0/0/0033/3/3/3/3/3/3/3/3// /03/200Financial health We regularly track the funding position of UK private sector pension schemes under standard accounting measures (FRS17 / IAS19) used in company accounts. We compare this against indicative market-based buyout costs to monitor how relative prices are moving with changing financial conditions and to assess how attractive a buyout type solution is at any given time. Funding Level (%) 40 Index FRS17/IAS19 vs. Buyout Year Deferreds 3Affordability Long-term corporate bond and gilt yields have both risen significantly during the first half of 2013, with the effect of reducing both accounting liability values and buyout premiums, although this effect was partially offset for index-linked pensions by increasing expectations of future inflation. Overall, the relationship between accounting values and buyout premiums has remained relatively stable; widening slightly in March / April 2013 only to narrow again by the end of June Over the six months to 30 June 2013, developed market equities increased in value, whilst corporate bonds and gilt holdings declined in value due to rising yields. Affordability Index Year FRS17/IAS19 Buyout Our affordability index tracks prices in the buyout market against FRS17 / IAS19 liability values and shows the relationship between average buyout premiums and accounting liabilities for deferred and pensioner members Our results show an improvement in affordability for both deferred and pensioner members. This was mostly due to increases in longdated gilt yields, which rose further than long-dated corporate bond yields over the six months to 30 June Market Sentiment Pensioners Market sentiment towards bulk annuity deals continues to be favourable as it is increasingly acknowledged that pension liabilities calculated on an accounting basis are not a realistic estimate of a sponsor s exposure. Many schemes are undertaking buy-ins as precurser to full buyouts of the liabilities. This has a limited impact on the company s accounts as it represents a trustee investment decision rather than a settlement of the liabilities. It also allows the sponsor / trustees to insure the membership in tranches, building up to a fully secured scheme which can then be formally wound up. Companies remain very keen to de-risk and continue to see a buyout as their longer term objective. This is confirmed by the fact that the majority of the larger deals completed over the recent past have been sponsor- rather than trustee-driven. Many trustees and companies are agreeing long-term targets (selfsufficiency or buyout), and setting trigger points at which they plan to de-risk through either investment switches or buy-ins. JTL offers clients a daily funding level and trigger monitoring service to enable clients to identify and capture de-risking opportunities. Buyout Market Watch 4

5 22013Q12013Q42012Q32012Q22012Q12012Q42011Q32011Q22011Q Q32010Q22010Q12010Q42009Q32009Q22009Q12009Q42008Q32008Q22008Q1200Market Statistics The chart below illustrates insurers relative buyout market shares based on deals completed since Legal and General 24% Others 1% Bulk Buy-out Business Written Q ( 20.7bn) Prudential 8% Rothesay Life / Paternoster 20% The following chart shows an average cross section across all major players of the value of quotations requested by sponsors / trustees during each quarter since Value ( bn) Value of Buy-in / Buyout Quotations from Lucida 3% 5 25 QMetLife 9% Aviva 12% Pension Insurance Corporation 23% 0 1QA comparison of longevity swaps and buyout deals transacted since 2009 is illustrated in the graph below Period Buyout and Longevity Swap Market Since m Year buyout longevity Commentary The appetite for de-risking solutions remains strong amongst both sponsors and trustees, as evidenced by the deals announced to date in Insurers remain keen to transact, given the right terms, and are open to innovation. Trustees and sponsors are aware of the risks and uncertainties associated with defined benefit pension scheme liabilities and continue to see the economic value of those liabilities as the true price that must be paid. JLT are already close to surpassing the number of transactions we completed in 2012 and, with additional transactions in the pipeline, we expect to complete materially more deals this year, with total premiums likely to be in excess of 500m. We expect 2013 to be a healthy year for de-risking deals for the market as a whole, with business volumes surpassing 2012 figures. Insurer pipelines remain healthy and our discussions with the insurers indicate continuing optimism for the end of the year. Given market volatility, it is imperative that schemes are ready to transact when the opportunity arises. As such, schemes should look to understand the likely price of a buy-in or buyout and consider the affordability of a transaction, monitoring the position if necessary. Steps should be taken to improve data quality, although this should not hold up a feasible transaction. Insurers are more likely to provide a quotation and enter into a competitive process where schemes have an understanding of affordability and there is ultimately a better chance of transacting. JLT currently have a conversion rate of circa 60% (as measured by an insurer), i.e. six out of ten schemes we take to market transact. This compares favourably with other consultancies, where on average only one in five schemes that come to market actually transacts. This should put the schemes we advise in a stronger position in the event that higher demand leads insurers to be more selective in the business they quote for. Whilst all reasonable care has been taken in the preparation of this publication, no liability is accepted under any circumstances by Jardine Lloyd Thompson for any loss or damage occurring as a result of reliance on any statement, opinion, or any error or omission contained herein. Any statement or opinion unless otherwise stated should not be construed as independent research and reflects our understanding of current or proposed legislation and regulation, which may change without notice. The content of this document should not be regarded as specific advice in relation to the matters addressed. If you have questions about any of the subjects raised in this issue of Buyout Market Watch, please contact Martyn Phillips, Director, Head of Buyouts (Martyn_Phillips@jltgroup.com, ) or Tiziana Perrella, Principal (Tiziana_Perrella@jltgroup.com, ). Buyout Market Watch 5

6 JLT Employee Benefits The St Botolph Building 138 Houndsditch London EC3A 7AW Tel +44 (0) Fax +44 (0) JLT Employee Benefits. A trading name of JLT Benefit Solutions Limited. Authorised and regulated by the Financial Conduct Authority. A member of the Jardine Lloyd Thompson Group. Registered Office: The St Botolph Building, 138 Houndsditch, London EC3A 7AW. Registered in England No VAT No JLT PCS /13