UK pension funds are poised to further reduce their support for the London stock market as employers accelerate a push to lock in higher bond yields and offload tens of billions of pounds of liabilities to insurers.
Industry executives said 2023 is set to be a record year for such transfer deals for defined benefit pension schemes, which promise to pay employees’ retirement payments at a fixed level. Rising interest rates have boosted these plans’ funding levels to their highest in more than a decade.
Several industry figures said this year would far exceed the previous peak of £44bn in liabilities transferred in 2019. Phoenix Group, one of the UK’s largest savings and retirement businesses, estimates £60bn in liabilities will be shifted to insurers this year, with important implications for asset allocation.
“The optimal assets to transition to an insurer is fixed income,” said Mike Eakins, chief investment officer at Phoenix. “That’s been a key strategic driver” of a shift out of UK equities, which is set to continue as pension schemes prepare their balance sheets for insurers, he added.
As schemes seek to complete a transaction with an insurer they move out of riskier assets such as equities and into bonds. These are a better match for their liabilities — the pensions they have promised to pay to their members — and preferred by insurers.
Ashok Bhatia, deputy chief investment officer at investment firm Neuberger Berman, said the market impact of this shift away from equity allocations will be “significant”.
But, he added: “It’s not going to happen immediately — it’s such a big change.”
The rise in popularity of the transfer deals has exacerbated a longer-term shift to fixed-income investments as defined benefit schemes’ demographics change.
“The biggest driver of DB pension schemes’ shift away from UK equities is the growing maturity of the schemes as more of their members move into retirement,” said Joe Dabrowski, deputy director of policy at the Pensions and Lifetime Savings Association, which represents UK pension schemes stewarding £1.3tn on behalf of 30mn savers.
Over the past two decades, holdings of UK-listed companies by British pension and insurance funds have plunged from about half of their portfolios to 4 per cent, while holdings of fixed income have surged from 17 per cent in 2000 to 72 per cent in 2022, according to data from advisory firm Ondra Partners.
This shift in asset allocation was partly driven by an accounting change in 2000, which forced companies to recognise pension fund deficits on their own balance sheets. Defined-benefit pension schemes piled into long-term bonds in order to offset big swings in their liabilities, adopting liability-driven investing strategies that largely eschewed equities.
So-called LDI, which uses derivatives to hedge against moves in long-term interest rates, was at the centre of last year’s UK gilts market crisis.
Last month, insurer RSA agreed to offload £6.5bn worth of its liabilities to Pension Insurance Corporation, in what was a record deal in the UK. PIC chief executive Tracy Blackwell said the pensions crisis sparked by Kwasi Kwarteng’s ill-fated “mini” Budget last year, rather than pausing the bulk annuity market, had “accelerated” it owing to the lift in funding levels.
Legal & General, the FTSE 100 life insurer, said in its full-year results on Wednesday that there had been a “step-up” in pension transfer deal activity. It took in £9.5bn of premiums from such pension transfer deals globally in 2022, up from £7.2bn the previous year, and highlighted its “strong global pipeline”.
On the same day, L&G chief executive Sir Nigel Wilson decried the “perpetual drift” of companies away from London’s stock market, attributing it in part to a decline in equity holdings among pension funds.
Insurers argue that, following a transfer deal, they will swap out some of the bonds backing pension scheme liabilities for economically productive investments such as infrastructure or housing. They have estimated that proposed easements to insurance solvency rules will allow £100bn to flow into such areas.
Like others in the sector, Aviva chief executive Amanda Blanc has advocated getting growth equity-like venture capital into defined contribution pension schemes, but said it would be “very difficult” for defined benefit pension fund trustees to reverse the long-term switch out of equities.
“Pension trustees went through quite a lot following the ‘mini’ Budget last year,” she said. “If I was one, I could only imagine that sitting here at the moment and thinking about taking a lot of additional risk . . . you are probably not going to do that.”
