UK Pension and Insurance Providers’ Risk and Liabilities in Turbulent Brexit Times

The UK pension market is the second largest in the world, holding 7.5% of global pension fund assets and a whopping 60% of the European pension market, only surpassed by the US. Pension fund assets summed up to approximately 121% of the national GDP in 2018 (for all retirement vehicles), or approximately $3 Tr USD, growing over 33% in the past decade.

81% of the UK population are currently signed up to a Defined Benefit pension scheme (mostly government-backed), and 49% to Defined Contribution plans (a sizable percentage having signed up for both types of schemes). Despite the current DB-dominated market, the UK DC market is growing rapidly, and is set to be Europe’s first trillion-dollar DC market by 2021.

Unfortunately, even market leaders can experience turbulent times. Brexit uncertainty has taken quite a toll on the British Pound and has affected businesses operating in the UK, with no easy solution in sight. Legislative changes in the UK and in Europe affecting pension funds and insurance providers have also had an impact. Despite a few years of turbulence and uncertainty, forecasts still predict growth in upcoming years.

What is rocking the boat in the UK life/pension markets?

Brexit: Ever since the vote to leave the European Union in 2016, the UK markets have been bumpy and the Pound’s value has been volatile, reaching historical lows. Furthermore, the Brexit deadline has been postponed multiple times already, so it’s anyone’s guess as to when or if the English parliament will ever reach an agreement over a deal with the EU.

The markets have since stabilized, but businesses and investors functioning in the UK are understandably wary of Brexit repercussions. A weakened Pound will increase inflation, which is expected to lower national savings and pension contribution. With fewer or decreased contributions, pension scheme deficits will rise, increasing future liabilities for pension funds. If a “Hard Brexit” occurs, the government may cut interest rates in an attempt to stabilize the economy, increasing pension/life providers’ deficits and risk.

In addition, most of the assets of DC schemes in the UK are invested in publicly traded equities, exposing them to significant risks linked to market performance. Brexit volatility has only exacerbated these risks.

New Legislation: UK legislators have doubled their efforts in recent years to guarantee sufficient retirement income for the general population without breaking the bank. This is a huge concern worldwide as the last of the Baby Boomers reach retirement, and the UK is tackling the problem head on. The main changes are:

1. State pensiones have changed from a two-tier to a flat-rate model. The government argues that this model is simpler, and that most people will be getting higher pensions in the long run, though experts claim that many people will get less, and that this is mostly aimed at relieving financial pressure on the government.
2. The updated Pension Scheme Act 2015, gives retirees in the UK more flexibility when choosing how to save for retirement, removing the traditional compulsory annuity there was in the past. Those annuities have made room for a wide range of flexible retirement solutions, in a something-for-everyone type manner.
3. Auto enrollment: Employers are now obligated to automatically enrol their workers in a pension scheme. Enrolled employees must have a minimum of 8% contribution rate, with 3% coming from their employers. This has greatly increased employers liabilities, with some employers seeing a 50% rise in liabilities.
4. Equal benefits for men and women: The government has ordered DB pension schemes to provide equal benefits and retirement ages for men and women for Guaranteed Minimum Pensions earned from 1990 onwards. This is estimated to cost DB schemes as much as £15 billion.
5. Solvency II: As the UK is still technically part of Europe, the European Solvency II directive still affects UK Insurers. Solvency II requires insurers to retain SCR on their balance sheet by stressing the best estimate and increasing reserves & liabilities associated with longevity risk.

What are Insurers and Pension Funds doing with their increased risk and liabilities?

The last official governmental report on pension liabilities in the UK in 2015 (before the Brexit vote), estimated a total of £7.6 trillion of total pension liabilities (public and private pensions). Only a third of those liabilities are funded, leaving two-thirds to de-risk and giving UK insurers and pension providers a reason for concern.

UK insurers and pension schemes are no strangers to de-risking. The de-risking market has existed for years, and the market has developed elaborate ways to manage and transfer longevity risk. The regulatory environment favors de-risking solutions, and de-risking pensions has become expected in most UK companies, and they are doing it through buy-ins, buyouts and swaps and risk transfer to the capital markets.

UK is the global longevity risk transfer leader

The longevity risk market is dominated by the UK, though there has been increased activity in the Netherlands, Canada, France and the US in recent years. The UK Longevity Risk Transfer market has seen continued growth and activity in the past years (besides a lull in 2016 due to the Brexit vote), and deals have become larger. Almost £200 Billion-worth of pension liabilities have been transferred in the UK since the market commenced in 2007, with recent deals reaching billions of pounds.

According to S&P, they expect an increased appetite for Longevity Risk Transfer in the UK in the near future, mostly in longevity swaps and and risk transfer through the capital markets. Prudential expects the Longevity Risk Transfer market to double in the upcoming years.

With an end to Brexit drama nowhere in sight, it is clear that life insurers will be looking for solvency relief and de-risking of their portfolios and pension funds will be looking to transfer liabilities onwards, along with UK businesses looking to de-risk their corporate pension plans. The upcoming months and years are sure to be eventful in the UK Longevity Risk Transfer market.

Vesttoo has developed advanced technologies for data-driven risk management, transferring actuarial risk to financial risk through the capital markets. Vesttoo specializes in risk modeling and alternative risk transfer for the Life and P&C insurance markets, providing insurers with a low-cost strategic risk management solution for immediate capital relief, value enhancement and liability hedging.