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Why pension insurance mega deals are losing appeal

Why pension insurance mega deals are losing appeal

Why pension insurance mega deals are losing appeal Pension insurance mega deals were once a vital component for many big businesses – however, a new report suggests they are losing some of their allure.

Recently, car insurance provider Direct Line took the decision against taking out a policy to cover the risks linked with its pension scheme (as we reported here) – even though the likes of British Airways, Verizon, General Motors and the London Stock Exchange all choose to outsource the headache associated with defined benefit plans that were once seen as a “noose around the neck” of a corporate balance sheet. So what has made the difference?

A Financial Times article investigated the issue and points fingers at the costs associated with pension insurance at a time when interest rates are at rock bottom. During a typical buyout, an insurer takes on liabilities that are funded by assets – but low rates increase these liabilities and make the deals even more expensive.

According to the report, executives at Direct Line decided that handing over part of its benefit plan “wasn’t worth it” – in part because of lower interest rates, especially on the back of the Brexit vote.
Direct Line is not alone, either. The report quotes Matt McDaniel, head of US defined benefit risk at Mercer, as stating that “a buyout feels like locking in really high costs” during this period with interest rates at historical lows.

The market also now appears to be examining different prospects to full buyouts – including buy-ins; and longevity swaps in which the risk of a pensioner living longer than expected is passed on to the insurer but the scheme retains the investment risk. There was a £16 billion deal of this kind involving BT back in 2014.

However, there still remains a major market for buyouts in place. The UK has typically been the largest market globally for such transactions – and research from Hymans Robertson points to there being around £12.4 billion of buyouts and buy-ins during 2015.

The question now becomes a case of “stick or twist”? Rates may be low now – but they may still be low in 10 years. Do companies wait for rates to increase or do they assume that insurance deals are unlikely to get much more affordable in the near future?

Related stories:
Direct Line aborts plan to offload pension scheme
The huge danger insurers are ignoring