Ensuring a smooth de-risking journey De-risking report 2018 Contents Ensuring a smooth Looking back at 2017 ...............................................................................................................................4 Getting the best value in the bulk annuity market ...............................................6 de-risking journey Is a buyout more affordable than you think?..............................................................9 De-risking report 2018 Run-off strategy: the ‘DIY buy-in’ approach ..............................................................12 When should buy-ins be collateralised? ........................................................................15 Where next for the bulk annuity market? .................................................................... 19 1 Ensuring a smooth de-risking journey Our credentials Size and volume Client-focused solutions Experienced adviser on transactions ranging in size Streamlined approach which includes from £2 million to £16 billion pre-negotiated contract terms for cost efficient and quick transactions Advised on the first buy-in transaction in 1999. We have subsequently advised this client on four Strong relationships with the provider market, further deals leading to the best solutions for our clients A team which has experience of over 700 The only adviser to have led transactions using all transactions, including leading 25 buy-ins and of the available structures buyouts in 2017 of which 6 were over £100 million Longevity risk is integrated within the investment Advised more than 20 schemes who have put risk framework to enable active decisions in place multiple buy-ins, using both umbrella Settlement is a key part of our fiduciary investment contracts and open market approaches offering and at the heart of our strategic advice Leading adviser to insurers on annuity portfolio sale transactions Advised on over half of all longevity hedge deals ever transacted Innovation We have an unrivalled history of innovation and embracing new ideas. For example, we were the lead adviser in respect of: The first collateralised buy-in The first all-risks buyout The first software tracking system to track live insurer pricing The first umbrella contract for repeat buy-in transactions The first novation of a longevity swap Our Longevity Direct offering was the first ready- made vehicle for pension schemes to access the longevity reinsurance market 135 pension schemes and six insurers/reinsurers use Willis Towers Watson’s market-leading Postcode Mortality Tool 2 willistowerswatson.com Welcome Welcome to Willis Towers Watson’s 2018 de-risking report, looking at the key themes in the longevity hedging and bulk annuity market over the next year. This report provides a look back at activity in the market during 2017, as well as an overview of what we consider to be the key themes for 2018 in order to help schemes ensure a smooth de-risking journey on a potentially bumpy road ahead. 2016 ended on a particularly strong strategies, the cost-benefit of collateralised buy-ins is an note and this continued into 2017. area of the market which we expect to receive more focus This was partly driven by pricing, with in 2018. On page 15, I explore the wider perspective on levels on pensioner bulk annuities in collateral. line with those last seen around the financial crisis. With a busy market and Finally, on page 19, Will Griffiths shares his views on what competitive pricing, on page 6, Louise we might expect from the bulk annuity market in 2018. Nash explores some of the tactics we used in 2017 to help schemes get the best possible value. At Willis Towers Watson, our market-leading team brings together experience and expertise across pension Combining this attractive pricing with strong equity returns consulting, insurance, liability management exercises means buyout may now be more affordable than previously and project management to help our clients find the right thought for many schemes, perhaps within touching solutions for them. We work alongside a wide range of distance if a proactive approach is taken. On page 9, clients as their strategic de-risking adviser, helping them Matt Wiberg considers how well-timed actions across both to identify and plan their end-game strategy, and the steps assets and liabilities, such as ‘member choice’ exercises, they can take along the journey. could shave years off your de-risking journey. We would welcome the chance to discuss further with Whilst many schemes are targeting buyout as their you how you can take advantage of the opportunities end-game, others are targeting a long-term run-off strategy. in this market for your scheme, and ensure your scheme’s Lok Ma compares the two strategies on page 12, de-risking journey is as smooth as possible. considering the journeys to each and how longevity risk management is key to both. As more schemes are transacting large buy-ins, as well as Ian Aley insurers becoming more innovative with their investment Head of Transactions 3 Ensuring a smooth de-risking journey Looking back at 2017 2017 was a busy year in the bulk annuity and longevity hedging market, with volumes in the first half of the year significantly higher than over the same period in 2016. Overall, as can be seen in Figure 1, volumes exceeded those of 2016 and in particular, the level of longevity swaps was higher than seen over the last few years. As well as schemes approaching the de-risking market for the first time, we have also seen a high number of schemes completing follow-on transactions. Indeed, our research shows that over one-quarter of the bulk annuities written in 2016 and 2017 were repeat transactions. What were the Why was 2017 such a good year for pricing? key drivers for the level of activity in the For the last 18 months, we have seen bulk annuity pricing market in 2017? for pensioners typically achieve a higher yield than that available on a portfolio of gilts as shown in Figure 2. Whilst Attractive pricing (relative to gilt yields) at levels last seen one of the reasons for the level of pricing is strong insurer around the financial crisis and reinsurer appetite and competition within the market, Insurer appetite other factors are: Greater longevity hedging opportunities for smaller schemes Reduction in life expectancy - following three consecutive years of higher than expected deaths, insurers and reinsurers are taking steps to reduce their life expectancy assumptions, Figure 1. Volumes of business by year improving pricing for both buy-ins and longevity swaps relative to the reserves being held by schemes. 40 25.4 Greater innovation in insurers’ investment strategies - 35 traditionally insurers have held a significant proportion £ billion of high-quality corporate bonds. Insurers are now 30 increasingly sourcing and deriving alternative assets 25 such as secure income assets (SIAs) (see Figure 3) and Lifetime Mortgages. These provide a good match 20 for cashflows payable to pensioners and benefit from 5.9 15 9.3 6.4 an illiquidity premium, feeding through into reduced 13.2 2.6 7.0 12.3 premiums. 10 10.3 11.0 4.3 Giving insurers time to source suitable assets – as 2.2 7.2 5 5.6 mentioned above, the best pricing in a post-Solvency II 4.9 4.5 0 world is available from a high-yielding, closely matching 2010 2011 2012 2013 2014 2015 2016 2017* investment strategy. Giving an insurer time to source suitable SIAs for a specific cashflow profile, by entering into Bulk annuities a price monitoring period, can lead to better pricing being Longevity swaps achieved. We cover this in more detail later in the report. *Transactions announced to date 4 willistowerswatson.com Figure 2. ‘Typical’ insurer pricing relative to gilt yields 'A' grade corporate bond spread above gilt yields (pa) 0.35% Over 2017, we helped 25 4.00% pension schemes to lock into attractive pricing 3.50% 0.25% Pricing attractive vs gilts 3.00% 0.15% 2.50% 0.05% 2.00% 1.50% - 0.05% 1.00% - 0.15% Buy-in yield above gilt yields (pa) 0.50% Pricing expensive vs gilts - 0.25% 0.00% Dec 2010 Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015 Dec 2016 Gilt yields Buy-in yield above gilts yields Corporate bond spread above gilt yields What’s led to the increase in longevity swaps? Figure 3. SIAs Whilst traditionally longevity swaps have been mainly These assets provide a secure income stream considered by the larger schemes, longevity swaps for generated from: as little as £100 million of pensioner liability have recently become considerably more attractive. These developments Real estate Infrastructure Real asset debt have partly been driven by Solvency II, which means most insurers have now put in place reinsurance treaties to hedge the longevity risk on both historic annuity business and new Contractual, inflation-linked, long-term cashflows business that they write. The increased flow of longevity risk to the reinsurance market has resulted in: Robust counterparties or tangible collateral backing Most economic value from cashflows A reduction in reinsurer pricing for smaller schemes. Limited economic exposure Smaller schemes are now benefiting from what has historically been ‘big scheme’ pricing as reinsurers absorb some of the more prevalent risks present in smaller schemes within their wider longevity risk portfolios. What will 2018 have in store for this market? Greater streamlining and standardisation of the contractual arrangements and running of hedges. What should schemes do to ensure a smooth de-risking journey? And what Is there capacity in the market to manage should schemes looking to transact the number of schemes looking to capture do to get ready? Read on to hear from this opportunity? our experts. Capacity means two things in the de-risking market: Willingness to write new deals (in particular for bulk annuity providers, they need capital to back those deals) Resource to price and implement new deals Whilst the first was not a problem in 2017, there were times when the market was particularly busy and insurers were selective on which deals to deploy their resources on at various points during the year.