Credit crisis sparks pension buyout slump

Soaring yields on corporate bonds are also forcing insurers taking on the schemes to reassess their risk, resulting in rising costs for buyouts, which are effectively the buying of a bulk annuity contract.

"Given the conditions in the credit markets over the past few weeks, insurers are taking a cautious view of credit risk going forward and that has led to prices nudging higher," said Clive Wellsteed, a partner at consultant actuary firm Lane, Clark & Peacock.

"Trustees will probably wait for the dust to settle to get a more orderly transaction from the scheme to the insurer."

The drying up of the buyout market compares starkly with early September, which saw the biggest bulk annuity transaction with telecoms group Cable & Wireless entering a 1 billion pound deal with Prudential.

Until recently companies had increasingly sought to remove the risk associated with their pension schemes by transferring assets and liabilities to an insurer. In a full buyout, companies get a "clean break" from their liabilities, with insurers taking on all pension payments.

Typically the cost of a full buyout is estimated at around 130 percent of the value of liabilities measured on the basis of the IAS 19 accounting standard. But over the past month, this cost has risen to up to 140 percent of liabilities.

Wellsteed said: "Buyouts are no longer the no-brainer they were six months ago. On the other hand, the last six months have highlighted to trustees and companies how much risk there is in company pension schemes and as a result of that they might be willing to pay more money to take that risk off the table."

Pension buyout company Paternoster's chief executive, Mark Wood, told Reuters the slowing down of the market was due to insurers' reluctance to price deals.

That reluctance has emerged because the credit crisis has caused a sharp widening of spreads between investment grade corporate bonds and government bonds, making insurers more cautious of pricing the corporate bonds that often constitute a large part of a pension fund's assets.

"The problem is when you are making allowances for defaults in these markets you have to be extremely cautious," Wood said.

"As a trustee you have to be careful that you are not giving away your corporate bonds too cheaply and as an insurer it becomes difficult for us to say that we are buying it at a sensible price because it is so difficult to assess what the future default will be."

The bulk annuity market was expected to grow to 10 billion pounds in 2008, almost quadrupling the 2007 levels. So far, however, business of only around 6 billion pounds has been written this year. The overall capacity of the buyout market has been estimated at 40 billion pounds.

Wellsteed expects the market to slow down in the fourth quarter.

"Given how markets have been in the past month or so, the fourth quarter will be much quieter than in the first three quarters of the year. I expect total transactions worth 8 billion pounds or so this year."

Wood agreed: "If I were a trustee I would not trade at this point. I would wait until there is more confidence in our ability to predict how bond prices move over the coming months," he said.