U.K. Pension Revolution Putting Long-Term Bonds at RiskJohn Glover
The biggest shakeup of the U.K. pensions industry in almost a century is threatening to reduce the pool of buyers for long-term corporate debt in pounds.
Chancellor of the Exchequer George Osborne last week scrapped rules requiring retirees to buy annuities with savings in defined-contribution pension plans. Long-dated bonds fell amid speculation insurers such as Legal & General Group Plc and Aviva Plc will scale back purchases of the assets they use to back payments to retirees.
“Clearly, if demand for new annuities is going through the floor, then demand for long-term credit is going to fall away, too,” said Mark Benstead, London-based head of sterling credit at Axa Investment Managers, which oversees about $590 billion. “There’ll be greater demand for five-to-10-year credit, less for 30 years.”
U.K. pension rules to date have supplied a stable source of demand for long-dated corporate bonds. The matching of assets and liabilities has skewed the market in favor of long-dated debt, with pound bonds having an average of 12.2 years to maturity, compared with 5.2 years for bonds in euros, according to Bank of America Merrill Lynch data.
The overhaul, which Osborne announced in his March 19 budget, affects defined-contribution plans, where the contributor pays in without knowing the size of a future pension. The government is also consulting on the future of the defined-benefit market, where members are guaranteed a pension of a certain size.
The stock of annuities is about 210 billion pounds ($347 billion), and the Association of British Insurers estimates 11.9 billion pounds was added last year. About 60 percent of the pension savings exchanged for annuities is invested in corporate bonds, according to the Treasury.
About three-quarters of retirees buy an annuity, according to government figures cited by Morgan Stanley. Moody’s Investors Service said yesterday that Osborne’s proposals are credit-negative for U.K. life insurers, which could see individual sales of annuities fall by between 50 percent and 75 percent.
Morgan Stanley analysts led by Andrew Sheets, head of European credit research in London, estimate that sellers of annuities hold at least 37 percent of longer-dated securities.
That flow “remains a big core support,” according to the report. “The long end of the pound market could see a widening of spreads and decline in issuance to adjust to the lower appetite.”
Following the budget speech, Electricite de France SA’s 1.35 billion pounds of notes due 2114 fell as much as 1.83 pence in the pound to 113.6 pence. Manchester Airport Group Plc’s 450 million pounds of 4.75 percent bonds due March 2034 shed 1.12 pence to 100.67, according to Bloomberg generic prices.
“Those long bonds are tailor-made for the U.K. credit market,” said Jorgen Kjaersgaar, a money manager at AllianceBernstein Ltd. in London. “U.K. issuance tends to be further out on the curve.”
Demand for long-term assets is reflected in government bonds. The weighted average maturity of the gilt market is 13.3 years, more than double German bunds’ average maturity of 6.5 years, data compiled by Bloomberg show.
Gilts are less likely to be affected by Osborne’s proposals because providers of defined-benefit pensions are key buyers, according to Robert Stheeman, head of the Debt Management Office. The assets of defined-benefit plans are more than 1.1 trillion pounds, according to the Pension Protection Fund 7800 Index.
“It’s those schemes that actually form the backbone of pension-fund demand for the long end of the gilt market,” Stheeman said on March 19. “We consider that there will be more than enough demand to support our long-end program this year.”
Investors get 79 basis points of extra yield to hold 30-year gilts instead of 10-year securities compared with 76.6 basis points on March 18.
Osborne decided to take action on defined-contribution plans in response to criticism that five years of record-low interest rates had aided borrowers at the expense of savers and pensioners.
A 60-year-old retiree with pension savings of 32,000 pounds who took 25 percent as a lump sum and bought an annuity with the remaining 24,000 pounds would get a maximum of about 1,250 pounds a year, according to a table published by the ABI. The median pension pot is about 20,000 pounds, meaning half are smaller.
Long-dated bonds might come under significant pressure if the government also decides to lift restrictions on defined-benefit plans, said Ben Bennett, a strategist at Legal & General Investment Management Ltd. in London. The Treasury consultation closes on June 11.
If savers in those plans “can take their money out and do what they want, that could lead to significant amounts of selling,” Bennett said. “Defined-benefit plans aren’t fully funded, so there isn’t enough cash to pay everyone at once. Letting people cash those in would be huge. It would have a massive impact.”