UK’s £1.1tn yields-boosted DB pensions should aid Aviva, L&G and Phoenix: Bloomberg Intelligence

The £1.1 trillion of UK defined-benefit (DB) pensions, boosted by yields, should benefit Aviva, Legal & General and Phoenix, which help firms offload pension obligations viewed as an unwelcome liability, Bloomberg Intelligence (BI) believes.

Thanks to a sustained rise in AA corporate-bond yields, DB pensions in the UK have been well funded, which signals momentum in the buy-in/buy-out market may extend to beat 2023’s record (£49.1 billion), analysts stated.

The AA corporate-bond yield for a 10-year-plus note, used to discount defined-benefit pensions, is at 4.6% vs. 2.7% in July 2022 and 1.04% the year before. It averaged 5% in 2023.

The long-term nature of pension funds and their funding makes it almost impossible to forecast the exact levels, with outcomes also likely different for every plan, BI explained.

Kevin Ryan, Senior Insurance Analyst at BI, commented: “The pressure on all defined-benefit pension funding has eased significantly in the past year, with aggregate FTSE 350 funding at 109% at the end of July.”

He added: “The average discount rate used by the companies in the UK jumped almost 3x in 2022 (4.9% vs. 1.9% a year earlier). This level sustained in 2023-24, offering corporate pension-fund sponsors a variety of options, including transferring the liabilities to an insurer or using the surplus in the business.”

Buy-in and buy-out deals have continued to accelerate, with volume hitting £49.1 billion in 2023, a trend that analysts predict may extend this year as bond yields stabilise at elevated levels.

Legal & General has managed some of the UK’s biggest pension buy-ins, including the £4.8 billion deal for Boots, the second-largest in 2023. As well as the £4.4 billion for British Airways in 2018 and the £4.6 billion deal for Rolls-Royce a year later.

According to BI analysis there were 11 transactions above £500 million in 2023 (vs. 15 in 2022), with the combined value of the top five at £20.4 billion.

Charles Graham, Senior Insurance Analyst at BI, said: “Many companies view staff pensions as both a distraction and unwelcome liability, so we expect the outsourcing trend to continue. Transaction volume in H1 appears modest, but Aviva and Legal & General expect a busier H2.”

Yields have risen steadily since July 2021 – under the IAS 19 rule, AA+ corporate bond yields are used to discount defined-benefit pension liabilities and are up sharply year-over-year.

Despite having seen some volatility this year, higher average yields are likely the new normal, analysts highlighted.

In March 202, the Covid-19 created a spike that drove yields sharply higher. Now, rising interest rates, combined with geopolitical uncertainty, have driven the bounce.

Graham noted that this is good news for insurance companies with two sources of profit: underwriting and investment income, but volatility still remains a challenge.

“Many companies’ defined-benefit plans should begin to appear better funded, making these more attractive to the buy-in, buy-out market. Still, challenges remain, with insurers uniquely qualified to manage them for pension-fund clients,” he stated.

In 2023, Aviva, Phoenix and Legal & General were leading UK market participants helping companies manage their defined-benefit plans, BI noted.

This can involve buyouts – whereby the insurer takes over the liabilities and administers the pension plan – or a buy-in – where the liabilities of the plan stay with the company, but the administration is handled by the insurer.

Both the pricing and the terms of these transactions, analysts stated, are unknown.

Ryan concluded: “Market figures indicate that in the year to December 2023 Legal & General had a 25% share by value of transactions and handled 19% of all deals (by number).

“The 2024 market shares are expected to be similar. So, it seems likely to us that Legal & General and Aviva will be able to manage their own pension schemes.”

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