The Road Ahead: Navigating the Evolving UK DB Pension Landscape

Despite recent cuts, the sustained high-interest rate environment has left the UK defined benefit (DB) pension market at a pivotal juncture. Funding gaps have narrowed, prompting many schemes to explore opportunities to undergo a pension risk transfer (PRT) — the process of insuring the scheme’s liabilities — as a means of offloading financial risk and securing member benefits.

Pension schemes of all sizes have looked to pursue PRT transactions, with the first mega-deal (£6.5bn) between PIC and RSA completed in 2023¹. Against this backdrop, the recent growth of the PRT market has significant implications for insurers, asset managers, and OCIOs. As insurers race to increase capacity to meet PRT demand, the ‘higher-for-longer’ interest rate environment and increasing PRT volumes signal a significant reduction in addressable capital for OCIOs and asset managers providing Solutions offerings.

Interest rates are expected to slowly be cut by the Bank of England with forecasts placing the expected equilibirum bank rate between 3.75% and 4.25% through 2026² (Figure 1). With central banks taking a cautious approach to cutting future rates and interest rates expected to remain well above the ultra-low levels seen post-Great Financial Crisis, it is crucial for market participants to act now. In this article, we explore how ‘higher-for-longer’ rates and the growing PRT market will impact insurers, asset managers, and OCIOs and discuss the actions that these firms can take to successfully navigate this market environment.

Figure 1: Bank of England actual and forecast bank rates, November 2022 to November 2026²

The Market Today

Shifting dynamics among OCIO, Solutions, and insurance providers have shaped today’s market landscape. Investment consultants have gradually expanded into the OCIO market, while Solutions businesses run by asset managers have grown significantly and have become prominent providers of bespoke funds for pension schemes. Meanwhile, insurers have played a key role by writing bulk annuities to insure pension liabilities, with 75% of UK DB schemes incorporating full insurance in their long-term strategies³.

Figure 2 below is a market map of addressable assets across UK DB pension schemes as at November 2024. On the vertical axis, are scheme funding levels, with the scheme size and corresponding insurer appetite on the horizontal axis. The pensions schemes have been bucketed into three categories: fully insured schemes, schemes with high funding levels (>95%), and schemes likely to be targeted by OCIOs / Solutions managers. In general, insurers are expected to continue prioritizing larger pension, well-funded schemes for bulk annuities. Schemes with funding levels below 95% are less likely to be insured in the near term, making them prime targets for OCIOs and Solutions asset managers.

The Market Today: 2024 Market Map of Addressable UK DB Pension Assets

Figure 2: UK DB market map as of November 2024. On the Y-axis is the funding % of the pension schemes. On the X-axis is the scheme AUM and the corresponding estimated insurer appetite^3,4.

Across the UK DB Pension market, we have observed that:

1. Insurers are consistently seeking opportunities to write bulk annuities

The appetite of insurers to write bulk annuities varies with the AUM of the target pension schemes and is highly dependent on the operational, administrative and pricing capacity of the insurer. Insurers must identify their ideal client size due to the need to strike the correct balance between fees charged on AUM and scheme complexity against the required operational and pricing capacity.

2. A significant portion of the UK market has already been fully insured…

Currently, UK DB pension schemes have about £2tn under management³ with approximately c.£0.45tn⁴ already insured with bulk annuities.

3. …with many other well-funded schemes (>95% funding) looking to insure their liabilities

Given that PRT is considered the gold standard by most schemes, they are likely to want to insure their liabilities. Multiple factors such as funding level, insurer appetite and availability of funds will dictate which schemes are able to receive bulk annuities first.

4. Schemes with <95% funding are those best targeted by the OCIOs and Solutions going forward

Given their funding gaps, these schemes are likely to be unsuitable for bulk annuity. They represent the addressable market for OCIOs and Solutions providers, as they are not likely to be insured in the foreseeable future. These schemes are also often likely candidates to consider outsourcing their asset management.

The Market Five Years from Now

Over the next five years, we expect pension risk transfers to maintain their current rate, significantly shrinking the addressable market for OCIOs and Solutions providers within the UK DB Pension space.

In the 2029 UK DB Pension Scheme Market Map below (Figure 3), this is reflected in the growth of the pool of UK DB pension scheme assets that are fully insured. As a result, assets in schemes with funding levels below 95% — addressable capital for OCIOs and Solutions providers — has been significantly reduced.

The Market Five Years From Now: 2029 Market Map of Addressable UK DB Pension Assets

Figure 3: UK DB market map for 2029. On the Y-axis is the funding % of the pension schemes. On the X-axis is the Scheme AUM and the corresponding insurer appetite seen across the market. The white arrows indicate the movements since 2024⁴

The trends that we see driving this shift in market dynamics include:

1. Sustained Pension Risk Transfer and Bulk Annuity transactions by Insurers

Larger volumes of pension liabilities will continue to be insured. As an example of the intent of the insurers, Legal & General, in its refreshed strategy, recently announced that it expects to write up to £65bn of bulk annuities between 2024 and 2028⁵.

2. Increased appetite among Insurers for schemes at the upper and lower ends of the AUM range

Insurers are likely to increase their appetite to insure to both large (£2bn+) and smaller (£50-£100m) schemes, meaning a more diverse range of schemes may be able to secure a bulk annuity.

3. Stagnating growth of OCIOs and Solutions businesses

As addressable capital for these market players is significantly reduced, it is likely that the growth they have enjoyed in recent years will stagnate. While OCIOs and Solutions providers that allocate to traditional asset classes will be particularly impacted, Solutions businesses with large alternatives capabilities or specialist offerings may be able to better weather the storm.

How Leading Firms Will Differentiate Themselves

Insurers, OCIOs, and Asset Managers will all face unique challenges in response to the changing market. However,  leading firms will implement key initiatives to effectively navigate these challenges. To ensure they are well-positioned for the future…

…Insurers should focus on:

• Making use of the interest rate plateau by continuing to onboard assets in the wake of continued reduced funding gaps
• Identifying their ideal client size due to the need to strike the correct balance between fees charged on AUM and scheme complexity against the required operational and pricing capacity
• Optimizing capacity to ensure parallel onboarding of multiple schemes can occur.

…Solutions Asset Managers should focus on:

• Making a strategic decision over the right client segments to target, recognizing that the current momentum in solutions growth may soon taper off. Clearly, a balance will need to be struck between short-term tactical opportunities and longer-term strategic moves.
• Executing further international diversification of their business to tap into new geographies
• Conducting a comprehensive review of the cost base, initiating cost optimization efforts where necessary

…OCIOs should focus on:

• Redefining current profitability targets as necessary and refocusing their business strategy around client acquisition and retention
• Evaluating and executing transformation efforts required to compete in a shrinking market. We have observed that OCIOs are increasingly looking to develop or acquire asset management capabilities to best position themselves to capture a larger portion of the value chain.
• Looking to diversify internationally or to new client segments (e.g., wealth, family offices)

Each industry participant faces its own distinct challenges in adapting to a shifting market that is seeing DB pension schemes removed from the market. Success will favor firms that ensure their long-term strategic planning is in place while positioning themselves to capitalize on short-term opportunities. Firms that do not adequately position themselves for success may swiftly find themselves at a competitive disadvantage.

References: ¹Pension Insurance Corporation. 2023. ² Econforecasting. 2024. ³Hymans Robertson. 2023. ⁴Alpha FMC Analysis. ⁵Professional Pensions. 2024.