U.K. life insurers are still able to charge attractive prices for bulk annuity transfers despite being constrained by the amount of assets available to back the deals, consultants say.

2018 is expected to be a record year for bulk annuity transfers, wherein insurers take on defined benefit pension risks from pension schemes. The deals can be either the more common buy-in, in which the scheme buys an annuity to cover its payments to a portion of the scheme members, or buy-outs, whereby the insurer assumes all the assets and liabilities of a scheme and insures the pensioners directly.

Consultancy Hymans Robertson estimated in July that buy-ins and buy-outs would total £18 billion in 2018, beating the previous record of £13.2 billion in 2014, while Aon PLC estimates that it could go as high as £20 billion. This excludes Rothesay Life PLC's acquisition of a £12 billion annuity portfolio from Prudential PLC. These insurer-to-insurer transfers, known as back-book deals, typically occur when a company wants to exit or reduce its exposure to the annuity market.

'Arms race'

The assets insurers buy to back the liabilities they take on in bulk annuity deals are a key driver of the price they charge. The greater the return compared with government bonds, the keener the price.

Illiquid assets, such as mortgage-backed securities and funding for large infrastructure projects and social housing, are attractive in this context because the matching adjustment under Europe's Solvency II insurance capital regime gives insurers credit for holding such assets until maturity if they closely match liabilities. Illiquid assets otherwise tend to draw hefty capital requirements.

But although demand for bulk annuities remains high as pension schemes scramble to off-load defined benefit liabilities, there is a limited supply of assets that closely match the cash flows of the liabilities, and so enable insurers to benefit under the matching adjustment. Martin Bird, head of risk settlement at Aon, said insurers are looking for "very bespoke" forms of debt that they can format so that the cash flows closely match their bulk annuity liabilities, rather than assets that would be available on public markets.

Willis Towers Watson head of transactions Ian Aley wrote in a 2017 article that while there is growing availability of the assets insurers are looking for, they are "still relatively difficult to source" and there is "considerable competition" for them.

"There has been something of an arms race over the past two or three years since the introduction of Solvency II for insurers to source those assets," said Bird. He noted that insurers have built up "quite sizable teams" of specialists to acquire such assets, and have also started looking beyond the U.K., for example to U.S. credit markets, for alternative sources. "That will continue," he added in an interview.

Noting the potential for £20 billion worth of deals in 2018, David Ellis, a partner at Marsh & McLennan Cos. Inc.-owned consultancy Mercer, said: "The biggest market in the past was £13 billion [of comparable deals] in the U.K., so finding another £7 billion of appropriate assets is not trivial."

He added in an interview that although insurers were pushing into new areas and finding greater opportunities, "It is obviously not a magic money tree where they can find an immeasurable amount of assets and take whatever they like."

Deal slippage possible

Adding to the challenge is uncertainty around equity release mortgages, which had been a particular favorite among U.K. insurers because they carry more credit under the matching adjustment than other assets. The U.K.'s Prudential Regulation Authority had sought to introduce rules at the end of 2018 that were expected to increase capital requirements for holding equity release mortgages. Insurers were granted a temporary reprieve Oct. 25 when the PRA decided to delay the rules by at least a year, but uncertainty remains.

The result is that deals are being pushed into 2019. Ellis said insurers have used a lack of assets as a reason to postpone deals in the past, particularly toward the end of the year, but added that he had heard it more in 2018 given the amount of activity.

Despite the constraints, insurers are still able to offer pension schemes competitive prices, Aon's Bird said.

"I think the insurers at the moment are doing a terrific job of delivering, through their asset pipeline, pricing that is attractive and I hope that continues," he said. "I think there is pressure in the system to continue to do that because asset availability is not unlimited, but at the moment there is no signs that pricing is dropping off."

And it seems not all are struggling to find assets. An Aviva PLC spokesman said the insurer's ability to find the right assets is "very strong" and that the company does not expect significant implications as a result of the heavy activity in 2018.

"There is obviously a demand/capacity trade-off but this is manageable," the spokesman added.

And although assets may be a constraint for some, there is still plenty of momentum in the U.K. bulk annuities market, and deals slipping to 2019 simply means an active start to the year. Ellis said: "I think next year could easily be larger than this year, and this year's been the largest year."