August 18, 2016 / 12:31 PM / 3 years ago

British firms face higher bill to escape growing pension black hole

LONDON (Reuters) - Britain’s vote to leave the European Union and a subsequent interest rate cut have worsened some companies’ pension deficits and raised the price they must pay to hand off the risk to insurers.

Miniature models of people are pictured in front of the European Union and UK flags in this photo illustration taken June 21, 2016. REUTERS/Dado Ruvic/Illustration

The state of UK Plc’s combined pension deficit is in the spotlight after the high-profile collapse of retailer BHS and Indian firm Tata Steel’s (TISC.NS) review of its British operations left the future of thousands of workers up in the air, and rules may yet be tightened to prevent a repeat.

Around 2 trillion pounds ($2.6 trillion) in pension liabilities sit on company balance sheets, of which around 1 trillion is in deficit.

That has led to rising interest from finance directors in striking a deal to farm out the risk to insurers, consultants say, even though they can be complex and take many months to bring to fruition.

One method of doing so is through bulk annuities, where an insurance company takes over some or all of the risk of managing a defined benefit, or final salary, pension scheme.

The number of bulk annuity deals has so far been relatively low because of their complexity and cost. A total of 12.3 billion pounds in such deals were fixed in 2015, data from consultants LCP showed, just below a record 13.2 billion agreed in 2014.

The pricing conversation with insurers has got even harder after the June 23 referendum vote and subsequent action by the Bank of England to boost the economy, particularly for schemes that were not well hedged or were backed by assets that fell in value and did not match liabilities so well.

“It’s definitely made it harder for most pension funds to secure bulk annuities for their liabilities in full,” said Guy Freeman, co-head of business development at Rothesay Life, as it had been made harder for many to plug their pension deficits.

While none of its current deals had been scuppered by a BoE move to cut interest rates and buy 10 billion pounds of corporate bonds, consultant Jardine Lloyd Thompson said the return-suppressing moves had raised prices.

BIGGER CAPITAL REQUIREMENTS

As well as widening the deficit of some schemes and making it harder to reach a funding level sufficiently attractive to strike a deal with insurers, it also meant the latter had to put more money aside to cover the risk under new Solvency II rules.

“There’s a lot of interest rate sensitivity in the Solvency II capital requirements there, so when interest rates come down, we get bigger capital requirements than you might expect, and therefore prices for new business moves up more than you’d expect,” said Rothesay’s Freeman.

Tiziana Perrella, principal at pension consultants JLT Employee Benefits, said the price rise was around 3 percent for deals insuring pensioners only, and 3-5 percent for taking on the extra risk of people who have not yet started drawing their pension.

A deal to pass on some of the risk, a so-called ‘buy-in’, is often easier to price than a deal for all of the risk, a so-called ‘buy-out’, given that smaller pools of scheme members, often those who are already retired, carry reduced interest rate and investment risk.

While some companies could still prefer to pump in as much money as necessary to get their troublesome scheme off the books, the pricing change may drive new entrants to shed the risk in smaller chunks, consultants say.

And after pension reforms in Britain last year cut the sales of individual annuities, which give a fixed income for life, insurance companies are increasingly looking to take on the profitable bulk risk from companies instead.

The biggest writer of bulk deals in 2015 was the Pension Insurance Corporation, whose 3.8 billion pounds in deals accounted for nearly a third of the market, LCP data showed, followed by Rothesay Life and Legal & General (LGEN.L).

Despite the pricing increase, however, Nick John, bulk purchase annuity director at Aviva (AV.L), said the pipeline for new business should eventually shrug off the post-Brexit vote lull in spite of a more uncertain economic outlook.

“Over the medium-term we think it is reasonable to assume that the pressure to de-risk will only increase,” particularly from companies headquartered overseas, which would likely have been helped by the post-Brexit slide in sterling.

($1 = 0.7714 pounds)

Additional reporting by Noor Zainab Hussain; Editing by Adrian Croft

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