A fine piece from Ford of the FT today on pension buyouts.
The premiss is that your pension is like a long term loan to your company, if you are in a company scheme, or to a life insurance company, if the scheme has been bought out. It is easy to see how the bought out pension is attractive to some life companies.
Just as our demanding bank borrower wanted, it gets no-strings, long-term money. Even better, it only has to pay a few basis points over government bond rates. No wonder so many clever financiers have homed in on pension buyouts — insurers such as PIC and Rothesay. After all, they get to reinvest some of the assets they inherit from insured schemes in higher yielding instruments, keeping much of the surplus earned over the rock-bottom funding cost.
Meanwhile, many of these insurers put up very little tangible capital. As they switch some of the transferred funds out of boring gilts into higher-return instruments, the regulator permits them to discount scheme liabilities at that higher rate. This essentially manufactures equity (a practice known as “Matching Adjustment”) by recognising up front future profits deemed to be risk free.
For many of the specialist players this is pretty much all their equity. Take the three most focused operators, PIC, Rothesay and Just Group. Collectively they had £13.7bn of regulatory net assets, according to their 2019 Solvency and Financial Condition Reports. But, strip out the Matching Adjustment, and that fell to just £172m.
Yikes.