Aviva PLC (LSE:AV.), Legal & General Group PLC (LSE:LGEN) and Phoenix Group Holdings PLC (LSE:PHNX) are expected to benefit most from a “paradigm shift” in the market for bulk annuities, when companies offload their pension schemes to life insurers, according to analysts.
The market for insurers taking over companies' defined-benefit pension has taken off over the past decade and enjoyed fresh momentum earlier this year as increases in government bond yields tracked rising inflation and interest rates rise, while the market turmoil in September and October led to expectations rising even higher.
RBC Capital Markets reiterated its ‘outperform’ recommendations for Aviva, Just Group PLC (LSE:JUST), L&G, Phoenix and XPS Pensions Group PLC (LSE:XPS) after hosting a bulk annuity seminar where expert industry speakers confirmed the view that the level of demand is likely to “far exceed available supply for the next decade”.
Dividends amounting to over a third of the sector’s market cap are expected, said RBC, as the large rise in long gilt yields this year feeds new business and lifts long-term capital generation.
The analysts also expect longevity reserve releases to be equivalent to 15% of the sector's market cap.
Demand for bulk annuity deals is rising as funding levels have improved such that 25% more schemes can afford a bulk annuity, the analysts said, resulting in a shift in supply-demand dynamics from next year.
New demand in 2023 is forecast to total around £100bn.
The analysts said: “High inflation is also a positive driver of pension scheme funding levels, as less sophisticated hedging solutions means that liabilities move up by less than assets in this environment.
“In addition, note that in general, legal advice for scheme trustees is that if you can afford to do a bulk annuity, then you should, as this is in the best interest of members.”
Also from next year, in particular from the second quarter onwards, the analysts said they expect many of the schemes that have had windfall gains in funding levels in 2022 will come to the market looking to do deals.
“Insurers will therefore likely be more selective, and we forecast margin improvement and lower capital strain…schemes will be chasing insurers, rather than insurers chasing schemes as has been the case in the past," they added.
It remains difficult for new entrants to join the current eight writers in the market, the RBC analysts noted, given high regulatory requirements and human capital constraints.
The seminar also highlighted that longevity reinsurance pricing “has never been so good”, though the outlook for UK longevity improvements is “more likely to be negative than positive”.
The RBC analysts estimated that longevity profits “will be a material driver of returns”, with international capital “queueing up” to get exposure to the UK bulk annuity market through funded reinsurance.
Aviva’s target price of 520p compares to the last close price of 445.5p, offering just under 17% of potential upside.
Just Group’s share price target offers the most upside of the RBC coverage at over 100%, with a target of 155p compared to 77.1p.
L&G’s target is 320p versus a share price of 255.3p), Phoenix’s is 740p versus 591p, and M&G PLC (LSE:MNG) has a target of 230p versus 191.2p.