Pensions risk transfer market resilient against Covid-19

Although market conditions may mean some schemes will be further away from being able to de-risk than they were before the pandemic, the market remains busy and others will still be in a position to proceed with planned risk transfer activity. We can also expect to see a greater volume of forced transfer activity reaching the market in the coming months and years as a result of sponsoring employer insolvency.

With some careful planning, and an eye on certain practical considerations, there is no reason why schemes in a position to proceed cannot achieve their risk transfer objectives despite the undoubted challenges posed by the pandemic.

A healthy deal pipeline

Many pension schemes which had already substantially de-risked their investment strategy before Covid-19 hit have been able to continue to de-risk through bulk annuities and longevity insurance transactions. Professional services firm Aon has recently predicted that around £50 billion of risk will be transferred to the bulk annuity and longevity swap market by the end of this year, which would be a remarkable outcome given the disruption and uncertainty caused by the pandemic.

This portrait of a busy market is consistent with our own experience over the summer and early autumn. We advised a number of businesses executing successful risk transfer transactions, including trades which were put on hold in the spring due to the market volatility arising from Covid-19.

Of course, the picture is not entirely rosy across the board. Some schemes have been more impacted than others by deteriorating market conditions, particularly those with greater exposure to equities and other growth assets. This has often coincided with significant uncertainty over the strength of the employer covenant supporting their scheme.

Schemes in this position may find that they are now further away from being able to afford to hedge their longevity risks or that they have other, more pressing, priorities. Trustees and employers in this position may need to recalibrate their long-term objectives for the scheme - which may include serious consideration of alternative risk transfer options, such as commercial consolidators and 'superfunds'.

It is, unfortunately, inevitable that some businesses will not survive the pandemic. Where a sponsoring employer becomes insolvent but the scheme has enough assets to secure benefits which exceed compensation levels available through the Pension Protection Fund (PPF), the scheme will look to secure 'PPF+' benefits under a bulk annuity. We expect to see a greater volume of these deals reaching the risk transfer market over the coming months and years.

Sponsor engagement

Pensions risk transfer deals require significant amounts of engagement and resource from both trustees and scheme sponsors.

One might reasonably assume that sponsor engagement could weaken as businesses grapple with the wider impact Covid-19 is having on their core business, but market activity so far this year suggests that this is not the case. Personally speaking, I've been impressed by the conviction which trustees and sponsors have shown to proceed with planned de-risking activity in the current environment. Of course, there is a strong rationale for this: removing pensions longevity risk means that there is one less risk for the business to worry about. A full scheme buy-out requires significant work upfront, but in the long term this will free up management time and resources to focus on the core business rather than the pension scheme, which must be more important now than ever.

The big question is for how long sponsors will maintain this conviction. There's no escaping the reality that many businesses are now focussing heavily on conserving cash and weathering the economic storm. In this environment, trustee requests for additional funding to enable further de-risking will be subject to greater scrutiny.

We are also seeing greater engagement from sponsors and trustees in assessing the impact of Covid-19 on the insurers shortlisted for the deal. They are, rightly, asking how insurers' investment strategies, provisions for claims, administration functions and capital ratios have been affected. The impact will differ from one insurer to the next but, reassuringly, the major market players are continuing to report strong financial positions and healthy levels of capital resources.

Of course, the question of credit risk can cut both ways, and so we are seeing greater focus from insurers and reinsurers in the longevity risk market on monitoring the funding position of the schemes they transact with.

Remote working practicalities

Along with these strategic issues, Covid-19 is causing a number of practical implications for the risk transfer market – both in terms of the widespread shift to remote working and video conferencing, and service limitations as we adjust to the 'new normal'.

Scheme administrators perhaps experienced the brunt of this. Many were forced to revert to providing only core services during the upheaval at the start of lockdown, and it was unclear whether they would have the capacity to support risk transfer deals and the associated additional administrative burdens. Again, in practice, this has not proven to be a barrier to deals completing, although we are seeing a trend towards longer timescales for completing the key administrative tasks under risk transfer contracts - particularly data cleansing obligations - largely as a precautionary measure.

Arrangements for administration site visits, during which the insurer or reinsurer can audit the scheme's administration arrangements or conduct due diligence for residual risks insurance, have also been impaired for obvious reasons. These require careful planning in order for them to take place safely.

We are seeing more focus on price-lock mechanisms and boundaries due to market volatility, as well as discussions around timescales for payment to address the risk of delays or problems in transferring premium payments to insurers.

On a very practical level, the move towards electronic documents rather than 'wet ink' documents has been keeping lawyers busy. Clear processes need to be agreed in advance of signing contracts including the use of electronic signatures; appropriate delegation of signing authority; and the use of software allowing documents to be signed electronically by multiple counterparties. Provisions in contracts requiring notices to be sent by post, and traditional insurer practices like holding physical 'expression of wish' forms in sealed envelopes, are also suddenly feeling quite outdated, and having to be reconsidered.