The growth potential of the UK bulk annuity market has been highlighted by a wave of new entrants, according to Fitch Ratings.
Steep interest rate rises in 2022-2023 boosted pension scheme funding levels, making it more affordable for corporates to transfer their pension liabilities to insurers.
Mutual insurer Royal London, for example, entered the market recently. Global investment firm Brookfield and UK insurer Utmost also plan to do so this year.
A strong demand from corporates to offload their pension liabilities represents a significant growth opportunity for the UK life sector, Fitch analysts believe.
This activity also underpins the sector’s improving outlook – the only one in Europe to hold this outlook, everywhere else in the continent it remains neutral -, assigned by the rating agency late last year.
“The steep interest rate rises in 2022-2023 boosted pension scheme funding levels, making it more affordable for corporates to transfer their pension liabilities to insurers. Bulk annuity transactions were close to GBP50 billion in 2023, the highest ever,” Fitch explained.
Adding: “We expect transaction volumes to remain large in 2024 and 2025 as strong demand continues and new entrants increase the life sector’s capacity to meet it. However, volumes may be lumpy from one year to the next given the large size of some deals.”
As the market develops, bulk annuity firms with critical mass, a strong franchise and access to capital are best placed to benefit.
On the other hand, new entrants face several challenges before they can compete, including regulatory approval and compliance with stringent Solvency II requirements, which calls for the development of complex models.
“To achieve this, new entrants will need to acquire the necessary actuarial and risk management expertise, in addition to asset origination capabilities. It also takes time to build relationships with pension scheme trustees and to establish a record of onboarding and administering schemes, which is important for credibility with trustees and for securing reinsurance on favourable terms,” Fitch stated.
The rating agency also noted that the Prudential Regulatory Authority’s 2025 life insurance stress test will apply to the largest bulk annuity providers, accounting for over 90% of the UK life sector’s annuity liabilities.
A financial market stress and separate scenarios covering risks associated with funded reinsurance and asset concentration will be included in the test.
“We believe rated bulk annuity providers should be generally well-positioned for the stress test due to their strong capital positions and effective risk management. Their interest-rate risk is minimal, as they select backing assets to match the annuity cash flows, or hedge the risk. Their main retained risk is credit risk, but they are capitalised accordingly, taking into account the credit quality of the assets they hold,” Fitch analysts said.
Adding: “Pricing risk is significant due to the large size and low frequency of bulk annuity transactions but firms scrutinise data from each annuity portfolio and reflect this in their pricing. In addition, most of the longevity pricing risk is passed to reinsurers, largely incentivised by Solvency II.”
