Following the UK’s vote to leave the EU, markets have been turbulent, with equity and bond markets both seeing their fair share of ups and downs. Sterling has devalued against almost all currencies. That all sounds like bad news for pension schemes and their trustees trying to navigate through their journey plan to ultimately securing all members’ benefits in an insurance contract. But are there a few silver linings? We think so!
Although a weak pound leads to worry on many fronts, not least the prospect of higher inflation and hence an increase in the cost of living, it does present a very real and immediate opportunity for pension schemes that ultimately are funded by foreign investors. Following the referendum, with the weakening in the pound, such schemes have seen an immediate drop in the debt they would need to pay to fund buyout. We don’t know for how long the current currency position will last, but there is an opportunity for schemes willing to move quickly and either transact with an insurer or hedge the current exchange rates.
Clearly, volatility in equity prices and government bond yields are generally bad news for pension schemes trying to trade. However, insurance pricing is driven by multiple other factors, not least corporate bond spreads. In uncertain times, corporate bond spreads tend to rise, which leads to lower insurance pricing, all other things being equal. The day after the EU Referendum saw the largest single day increase in credit spreads since global financial crisis began in 2008.
Average credit spreads for the mix of bonds in which UK life insurers would typically invest increased by around 100bps during the Eurozone difficulties in 2011/12. It remains to be seen what will happen now, but this scale of impact would be expected to improve insurance pricing relative to gilt returns by over 5% and potentially as much as 10%.
So we expect there to be good pricing opportunities in the months ahead, but your scheme needs to be able to act quickly, which is not the norm in the bulk annuity market.
If your scheme is prepared and can move to transact quickly, you will be best placed to take advantage of such opportunities when they arise.