The BCG Pension Insider

December 2020 – Volume 110, Edition 1

BCG Participates in Citi European Life Insurance Research Webinar

BCG’s Steve Keating was the featured speaker on a webinar sponsored by Citi’s European Life Insurance Research on December 14th on the topic - U.S. Pension Risk Transfer Market Trends. Webinar attendees were equity investors in U.S. life insurance companies. Below are Q&A highlights from the event:

Citi: What are your expectations for full year 2020 US group annuity sales?

Keating: Year-to-date sales were $11.6B across 256 deals through September 30th. The second quarter and first half of the third quarter for PRT transactions were definitely muted due to the pandemic and company’s focus being elsewhere, especially in the larger retiree only deal market. Retiree only deals typically are more discretionary than plan terminations, hence the smaller case market which is driven more by plan terminations showed more resilience. That said, Q4 was very active across the entire PRT market, where we are now expecting full year 2020 to finish around $27B (down from $30B in 2019) which advisors and insurers have found very robust given business conditions, financial volatility and priorities across the business landscape.

Citi: Do you have a perspective on what you think the US PRT volumes will be in the next 3-5 years?

Keating: We feel strongly that legacy obligations like closed and or frozen pension plans hold back companies from attracting new investors and creating both a focus and narrative related to the core business. As attractive opportunities for plan sponsors to offer lump sums dwindle and plan sponsors have addressed the relatively high costs associated with small benefit retirees, more plan sponsors will likely focus on purchasing annuities for a larger segment of retirees and/or pursuing full risk transfer through plan termination as well as more comprehensive LDI approaches. There may be a slowdown in plan terminations in 2021 given plan sponsor attention was elsewhere in 2020 (i.e., new plan term filings were likely down) but the market is expecting 2022 to be a big year for plan terminations with lots of pent-up demand. DB plans are certainly diminishing in the US, yet there remains a very large number of plans (including hard frozen plans) with large retiree populations, so in our view the US PRT market will be very active for many years to come.

Citi: Are you expecting demand to outstrip supply over this 3-5 year period and if so where do you see the most likely source of additional capital to fill this gap?

Keating: It’s possible that organic insurance company capital will be insufficient for demand. However, we expect reinsurance and external capital sources will expand and meet the growing demand.

Citi: In the UK you are seeing companies increase their allocation to illiquid investments to enhance returns. Is this same trend playing out in the US and if so what type of illiquid assets are being used and do any companies stand out with asset origination competitive advantages?

Keating: The same trend is true in the US with illiquid allocations increasing over recent years, but with the pace of growth probably a little less than in the UK. The most common asset classes are Commercial Mortgage Loans and Private Placements. US insurers have a long history originating these assets so are generally starting from a higher base than UK counterparts. Most US insurers in the PRT space have their own origination capabilities in these asset classes. The largest companies such as Metlife, Prudential, MassMutual, Principal have scaled US origination businesses in illiquids but they also need to write more volume.

Citi: There have only been a few longevity reinsurance transactions in the US but this is common practice in the UK. Do you expect this to change going forward?

Keating: The lack of a CPI (or Cola) promise in the U.S. DB plan market has held back demand for pure longevity protection. That said, the first of its kind longevity reinsurance transaction in the US was completed during the first half of 2019. The transaction covered a portion of the ceding company’s in-payment participants with ~$1 billion in statutory reserves. Based on that transaction getting done, we do expect others and we know of several reinsurers who are eager to write business in the US. The upcoming longevity charge for risk-based capital may cause ceding companies to consider some form of reinsurance, though we don't see it materially impacting pricing. There’s an offset for life insurance mortality and companies that write PRT tend to have a lot of asset and ALM risk which diversifies the charge even further.

We do expect more product development and innovation that would allow plan sponsors to evaluate and consider longevity risk transfer for their own pension plan. In the US, more and more plans are getting further down their asset de-risking paths, some to what we call the plan’s “hibernation” state. At hibernation, a plan is near or fully funded, has a full interest rate hedge and a small allocation to return seeking assets. It’s at this stage where longevity risk becomes a more meaningful component of overall plan risk and we can see solutions coming to market that would help these plans evaluate the cost of a longevity-only hedge vs. an annuity buyout. Of course, longevity only pricing would need to deliver meaningful savings relative to a single premium buyout.

To inquire about any of the topics covered above, please contact Steve Keating at 203-955-1566 or skeating@bcgpension.com. Thank you.

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