Are Mega-Buyout Deals on the Cards?

(July 10, 2013) — Music group EMI’s £1.5 billion buyout, unveiled on July 9, has reignited interest in the pension risk transfer market, leading to the prediction of a few more mega deals before the year is out.

Government bond yields and high-quality corporate bond yields have increased in recent weeks, combining with a brief rally for equities to narrow funding gaps and create buying opportunities for pension schemes.

As the deficits lessened, employers and plan sponsors have found themselves more willing to offer a sweetener in the form of a cash injection to help the pension fund reach the transaction point.

While the EMI deal in the UK is a specialised case, all of the derisking experts aiCIO spoke to admitted to an increase in interest from pension funds seeking to transfer risk.

Glenn O’Brien, managing director of Prudential’s pension risk transfer business, said the US was starting to see an increase in sponsors willing to transact.

“I was less optimistic [about the buyout market] at the beginning of the year, as companies were focusing on their year-end disclosures. But the macro-economic situation has improved and we’re starting to see a pick-up in interest in companies willing to deploy cash,” he said.

“As funded statuses improve through the movement of rates, pension funds will find they’re closer to being fully funded. It’ll be hard for a lot of transactions to happen all at once, but certainly more will be considering a pension risk transfer.”

O’Brien also said he believed the US pension risk transfer market could “top $5 billion” in deals this year, adding: “I get the sense there’s potential for one or two more large deals this year too.”

The increased interest in the US was confirmed by Ian Aley, head of pension risk solutions at Towers Watson. This was in part because there are two issues the UK suffers from which don’t apply to the US market.

“There’s no inflation linkage issue, unlike in the UK, which from an insurer’s perspective is helpful,” said Aley.

“And unlike in the UK, where pension funds pay benefits to the member and their spouse at the time the member dies”-i.e. if the member marries after they begin drawing benefits, the insurer has to honour their spouse even though it wouldn’t have known about at the time of pricing-“in the US they have individuals who are named up front, so it’s easier to absorb that risk.”

Emma Watkins, partner at consultant LCP, was convinced the improving macro-economic situation was the key factor behind any forthcoming transactions.

“On the basis that pension risk transfers are where most people are heading, the biggest barrier is the funding gap,” she said.

“When we were in an environment of low gilt yields, the price for deferred liabilities had a much bigger gap than what we see today.

“If you can close that gap through gilt yields increasing and at the same time see assets, such as equities, returns’ increase, you could get to the point where an employer is willing to put in a cash injection to get it over the line.”

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Watkins also predicted the UK trend for pensioner buy-ins would continue, along with one or two large buyouts.

“From 2012, we saw the decision to transact on a buy-in being taken strategically by larger schemes, rather than what was happening in the two years before, when pension funds took the opportunities when they were there,” she said.

“It’s not a tactical decision any more: it’s a strategic one, and we’ll see more of that in 2013. We may see one or two more large buyouts over the next 12 months, but we’ll certainly see more buy-ins in the next six. There are at least a couple of £500 million deals being transacted on right now.”

Others weren’t so convinced of a wave of transactions occurring, at least not in the UK.

David Ellis, Mercer’s UK bulk pensions insurance leader and lead adviser to Citi on the EMI transaction, said: “If you’re asking ‘have I seen more interest from big employers?’, then yes. I’ve seen three deals recently where there’s been a big capital injection from the employer, although I can’t disclose if Citi/EMI was one of them.

“This isn’t a trend though. The UK’s got a £5 billion buyout market a year roughly, and 50 deals are done in that time, 50 deals out of 6,000 pension funds. It’s not a trend; it’s a random selection of companies who are doing this.”

Dominic Grimley, principal consultant in Aon Hewitt’s risk settlement group agreed. Interest might be there, but deficits haven’t repaired enough for there to be a “mad rush toward buyouts”.

“We’re likely to see more buyouts being considered, but in most cases pension funds are still substantially underfunded.

“Looking at it the other way, L&G have taken on more than a billion with the Lucida sale, PIC has taken on £1.5 billion here, so there’s only Prudential and Rothesay Life left to pull out a big deal by the end of the year. I’d imagine if they’re keen to get a transaction of [EMI’s] size in this quarter, it might lead to some pricing pressure.”

The Dutch market is also likely to struggle with pension risk transfers, at least for the short-term. Despite several insurers expressing an interest in the Netherlands’ market-including Legal & General, one of the biggest buyout players-there’s some pieces missing from the puzzle.

Towers Watson’s Aley explained: “In Holland, a number of insurers and reinsurers we speak to have an interest in the Dutch market [for pension risk transfer deals]. But, and this is a massive oversimplification, broadly they see it as the next big market to develop, but it’s not there yet.

“One of the issues for Dutch pension funds is the difference between longevity assumptions between themselves and insurance companies. In the UK, the two models have more or less merged, but in the Netherlands they’re further apart.”

Asked what would happen to deals in the pipeline if the world became more volatile, through missives from central banks for example, Aley said: “In reality, many funds, having taken the decision that annuitisation in this form is sensible, they’ll have already begun aligning their assets to the strategy an insurer would take, and so the deal’s likely to continue.

“But for those who haven’t done that, they may well see the price has widened and seek to use the next transaction window instead.”

The US then, appears to remain the market to watch for the pension risk transfers.

Related Content: Music To Their Ears: EMI Buyout Agreed at £1.5 Billion and Popular De-Risking Deals Rise In the US and UK