This latest Opinion piece is by Sai Perry, Head of Solutions Europe and Asia, Clearwater Analytics. It looks at the challenges faced by pension fund managers, as they look to navigate the choppy investment waters ahead.
The recent turbulence that has been impacting pension funds over the last two months has shone a light on the benefits for these funds in transferring their liabilities over to insurers. But this isn’t a new concept. There are a multitude of driving factors pushing pension funds towards this kind of scheme , however, there are operational questions that remain unanswered.
In a lot of ways, the concept makes sense. Pension funds may not have the investing expertise in-house to secure the required returns on a consistent basis, and insurers are well-versed in employing low risk, long-term investing strategies. On top of this, it empowers corporates to focus on their core business activities, whilst providing trustees with peace of mind. Allowing insurers to take the reins and farm the capital out to specialist asset managers can work really well. The inbuilt insurance policy that ensures that the end investor can draw their pension at maturity date provides confidence at a time when economic instability can be worrying to those reaching retirement age.
There is expected to be a boom in this type of business – as reported recently in the Financial Times. Not only are pension funds being hit by margin calls that are calling into question the LDI investing strategies that many have been employing, but the pricing of these risk transfer deals is currently favourable to them. As the pricing is driven by the yield of the book of assets being transferred, and yields have generally increased, pricing should be more attractive to corporate schemes at the moment. This will also contribute to an increase in the volume of deals that the market is seeing.
There is also a regulatory angle that could be working to drive deals over the next few years. Financial regulators made a statement last week in response to the pensions crisis, that they will be looking to change their regulatory approach to governing these funds. It is possible that there will be greater regulations employed governing the amount of capital that pension funds need to have in reserve – placing a greater regulatory burden on corporate pension schemes.
As insurers have been dealing with these kinds of capital requirements imposed by Solvency II for over half a decade, it makes sense to pass the portfolios over to them. A significant value-add benefit to this type of scheme is that it allows pension funds to allocate a certain amount of their capital towards private market assets, with the allure of higher yields on that portion of the portfolio – especially in periods of depression in public markets.
FUTURE ASSET VALUES
Insurers that are acquiring these pensions portfolios typically have much larger books than the corporate pension funds do themselves, which means they are able to take a bigger stake in illiquid assets. It is also to their benefit to do this from a Solvency II perspective, as the regulation treats certain assets more favourably from a capital charge perspective. The payoff is that they are harder to shift but this shouldn’t be an issue for insurers, who generally have greater flexibility to amend strategic or tactical asset allocations in periods of volatility.
There is an operational issue here though. For insurers providing pension risk transfer services, they need to be able to account for private assets alongside the more vanilla investments, such as long dated bonds, through a holistic view of the total portfolio – especially if it is being managed by a variety of asset managers with different specialities. On top of this, due to the irregular nature of pricing private market assets, data flow is much slower and more limited. There is a significant time lag which makes it even more important that the data that is collected is accounted for and easily accessible across the business – as well as being of an extremely high quality.
The other thing to be considered is the need for speed. In H1 of 2022, 78 deals in the UK amounting to over £12 billion were completed, with over half of those deals being worth less than £1 billion. What this means is that there is a large volume of deals being processed, which stresses the need for speed in completing deals and reallocating assets. Insurers need to be able to quickly onboard assets from a corporate scheme and then rapidly get the assets working to create returns. This is where they start to feel the benefit of cloud-based, multi-asset and cross department operational systems.
It is clear that we are on the brink of a boom in this kind of business in the UK. The question now is – are insurers prepared for it? Those who are operationally set up to take on these pension fund books are the ones that will reap the long-term rewards.
Be the first to comment