Pension buyouts are worth around £50bn a year, according to one pension consultancy (Image: Getty)
The UK pension sector’s assets were valued at just under £3trillion towards the end of 2023.
Some of that money is held in private sector final salary schemes. These schemes are self-contained, so pension companies or providers do not run them but are entities in their own right.
But they are expensive to run because they guarantee a retired income based on a final salary. In recent years these schemes have been scaled down and no longer available to most UK employees, who are offered a different type of pension.
At the beginning of 2024, around 3.73 million employees were still members of fully open final salary schemes in the UK.
The companies running these final salary schemes have been selling them to insurance companies, which offer to run them instead. The sponsoring company no longer has to put resources into administrating and investing its pension fund.
Instead, insurance companies, including big names like L&G and Aviva, take on the schemes and pay out the pensions of those who’ve retired and guarantee the pensions of those who are in the pension but have not yet retired.
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Final salary schemes hold a lot of money, so insurance buyouts and buy-ins are big business.
A buyout is when the pension scheme sells lock, stock, and barrel to the insurance company, and buy-in is when the pension is kept by the company, but the insurance company agrees to run it. In both cases, a bulk annuity is bought to guarantee all the pension members get their savings.
Pensions consultancy Lane Clark & Peacock (LCP) said buy-in and buyout business was worth £50bn a year.
This is because many of these private sector defined benefit (DB) schemes are fully funded – so they have enough assets to cover the pension and benefits of all scheme members.
This means they can get a good deal by selling themselves to an insurance company.
Last year, Royal London entered this market, which is known as the UK’s pension risk transfer market, because it transfers risk to the insurance company rather than the company running the pension.
In 2023, M&G re-entered the bulk purchase annuity market, taking the number of UK providers to nine.
Buyouts are only conducted by a handful of large insurance companies, including Aviva, Phoenix, M&G, Just and Legal & General.
In the rush to seek a buyout, or ‘de-risk’, fears have been raised over too much concentration in a limited market.
In its Vision 2030 report, published in September 2023, the Society of Pension Professionals (SPP) warned that insurance buyouts “may not always be the answer”.
The SPP’s report also highlighted what it claimed were “inherent risks” in many schemes seeking the insurance sector’s umbrella.
It said more needed to be done to support and encourage schemes to carry on running themselves rather than feel they had to seek what pension industry experts call an “endgame” or buyout.
The paper argued that fully funded pension schemes could secure their members’ retirement income without needing to rely on the pension’s sponsoring company, which meant they could stay invested.
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The SPP research paper also warned that current proposals to adjust the Solvency II regulation, which decides how much capital insurance companies need to hold, may make things more risky.
The SPP cited a Bank of England estimate that would lead to a 20% increase in the annual probability of life insurer failure if a firm met just the minimum regulatory standard.
The SPP added that it might be “imprudent” to always assume that an insurance company would be stronger than a corporate sponsoring company.
Also, when a scheme’s assets are transferred to the insurer, it no longer comes under the protection of the Pension Protection Fund.
However, insurers are covered by the Financial Services Compensation Scheme (FSCS), which would be able to step in and support pensioners if the insurance company went bust.
But SPP’s argument is that FSCS protection could fall back from 100% if circumstances changed and that meant that if insurers fail, the FSCS may not be able to charge sufficient levies on the sector to cover the funding required.
In April 2023, the Prudential Regulatory Authority (PRA), which is part of the Bank of England, warned UK insurers to exercise moderation when taking on the liabilities of DB schemes.
In a speech at the City’s 20th annual conference on bulk annuities in April, Charlotte Gerken, executive director of insurance supervision at the PRA, expressed concern over the insurance market’s capacity to take on pension scheme liabilities.
She said the PRA was concerned that insurers were taking on more buyout business and were “expanding their risk appetite, sometimes outside their current core expertise.”
A spokesperson from an insurance company which specialises in buyouts said over a million pensions have been insured through bulk annuity purchases and buyouts and that insurance companies are required by law to hold large reserves. These capital requirements meant they were able to meet all financial commitments, even in extreme economic scenarios.
The provider pointed out that so far no insurance company has defaulted on its buyout commitments and it should be seen as a way of protecting retirement benefits.
It also meant that the pension member would benefit from being a customer and policyholder of the insurance company.
