December 17, 2007 / 9:28 AM / in 12 years

Pensions buyout market set to finally spark

LONDON (Reuters) - More deals to transfer the costly pension liabilities of British firms to insurers are likely in the coming months, after a recent flurry of transactions suggest the much-hyped market may at last be set to ignite.

Shipping firm P&O said on Friday it had done a deal to transfer 800 million pounds of pension liabilities to buyout insurer Paternoster, thought to be the biggest deal so far.

It follows hard on the heels of similar deals done by Paternoster with UK oil firm Lasmo and media group Emap EMA.L, while rival Legal & General (LGEN.L) has also been active, say consultants.

The recent flurry of deals may indicate that the 1 trillion pound buyout market for Britain’s defined-benefit company pensions is moving up a gear after a slow start.

“I think we are seeing the market taking off,” Mark Wood, CEO of Paternoster, told Reuters.

“The the fourth quarter will be a multiple of what it was in 2006,” in terms of volume of deals done, said Wood. “In fact we have probably seen more than 2 billion in trade (in the market as a whole) in the first two weeks of December alone.”

More — and bigger — deals are likely in the coming weeks, as companies scramble to complete transactions by the end of their financial years, say consultants.


Of the UK companies that have already closed their defined-benefit pension schemes to new members, one third are considering offloading their pension liabilities, said a recent PwC survey of 193 large UK firms.

“We are working with a number of FTSE100 companies on exploring their pension buy-out options and expect an energetic increase in activity next year,” said Marc Hommel, a pensions partner at PricewaterhouseCoopers LLP.

By transferring their pension liabilities to insurers to manage for a price, firms get rid of a big financial headache.

Recent rule changes have forced firms to recognise their pension deficits as debt on their balance sheet, limiting their ability to return cash to shareholders, fund M&A or improve credit ratings.

The growing cost of their pension schemes has crimped profits and blunted the competitiveness of many British firms, while some even said they had been forced to cut jobs to fund the extra contributions, a survey by the Confederation of British Industry in October revealed.

Also, by paying insurers to assume the longevity risk as well as the investment risk in the scheme, companies can rid themselves of the threat that they will keep having to put more cash into the scheme in future because its members live longer.

While the small number of deals done so far means it is too early to tell how transferring pensions may improve a company’s valuation, Emap’s pension deal was seen as a crucial first step in enabling the company’s subsequent break-up.


Until recently the market has been characterised by a steady trickle of tiny deals, with an average size of 4 million to 6 million pounds, according to research by Aon Consulting.

But that headline masked feverish quoting activity, with many sizeable schemes approaching buyout firms to find out how much it would cost them to take their pension liabilities.

In one week, Paternoster issued quotes on schemes with a total value of around 3.5 billion pounds, said Wood.

The cost of doing a deal has provided a brake on the development of the market, however.

Although competition among buyout firms has brought down the price, firms may have to top up their pension schemes by millions of pounds to provide for insurers’ more conservative estimates of life expectancy, as well as pay them a premium that covers their cost of capital and delivers them a profit margin.

UK telecoms firm Telent plc TLNT.L would have had to pay an extra 150 million pounds into its 2.5 billion pound pension scheme to bring it to a level that would have enabled it to be transferred to a buyout insurer.

Instead, Telent agreed to be acquired by Pension Corporation, a specialist pension fund manager led by financier Edmund Truell, for nearly 400 million pounds.

What has changed in the last few months is that the funding levels in many corporate pension schemes have improved to a point where they can consider offloading the liabilities.

Firms have been pumping billions into their schemes — a record 13.4 billion pounds last year alone, according to consultants Lane, Clark & Peacock — while their pension schemes have also been the unlikely beneficiaries of the recent credit crisis sparked by the subprime mortgage crisis.

A major factor driving the pension funds’ swing into the black is the falling value of AA-rated corporate bonds, which firms use as a benchmark measure for valuing their liabilities.

As the value of these bonds has fallen, due to rising fears of default among investors, so the cost of liabilities in firms’ pension schemes have been cut.

The result is that “many companies are able to shift the cost of their defined benefit pension plans off their balance sheet without putting any real new cash in,” said Wood.

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