Martin Luther King Jr once said that within capitalism, “a small privileged few are rich beyond conscience, and almost all others are doomed to be poor at some level”.
Legal & General Group PLC (LSE:LGEN) would have politely disagreed with the revered American activist.
According to the FTSE 100-listed insurance giant, its highly lucrative pension risk transfer (PRT) business operates under the guiding principle of ‘inclusive capitalism’, with its foundations paved with your pension money.
L&G’s brand of inclusive capitalism has certainly been inclusive of substantial profits and generous shareholder returns.
But can there truly be ethical consumption under capitalism, or is it all smoke and mirrors?
De-risking death
PRTs work as a typical insurance contract in that L&G assesses risk and charges a premium to take on that risk.
Specifically, the trustee of a defined benefit pension scheme, say Boots, pays a premium to offload its pension obligations to L&G.
In the case of, say, motor insurance, an insurer pays claimants as and when an accident occurs within the scope of the insurance contract.
For L&G, it’s not the risk of accidents but the dark arts of assessing longevity risk that determines profit margins.
In a sense, it’s the opposite of accident risk that’s at stake for L&G- if a policyholder lives longer than expected, profit margins are squeezed as monthly payments are dished out for longer.
Unlike a standard longevity swap, which covers the risk of policyholders living longer than expected, PRTs transfer all risks from the trustee to the insurer, including investment risk and inflation risk.
There are two types of PRT arrangements. In a ‘buy-in’, L&G makes regular payments to the pension scheme's trustees, who retain the obligation to pass the payments onto policyholders.
In a ‘buy out’, trustees wipe their hands of the pension fund entirely, passing the obligation to pay policyholders onto L&G.
In both instances, the financial mechanics of risk remain the same.
Profiting off shorter lifespans, which is effectively the underpinnings of L&G’s PRT business, may leave a bad taste in some people’s mouth, but for the trustees of legacy defined benefit schemes, it reduces the risk of accruing large deficits.
Take BT Group PLC (LSE:BT.A)’s infamously large pension deficit which, although it fluctuates up and down, stood at £4.8 billion as of this March.
BT expects to retain a pension deficit until 2030. In the meantime, it remains an overhang on BT’s balance sheet as billions are spent on covering the shortfall.
Though BT has a longevity swap arrangement with Reinsurance Group of America, it has not conducted a PRT.
Everyone’s a winner?
A lot of the discussion around PRTs revolves around reducing risk for trustees, but PRTs are also less risky for policyholders, at least according to L&G.
The insurer states: “No insurance company in the UK pension buyout market has ever defaulted against its policyholder obligations.
“By contrast, more than 2,000 defined benefit pension schemes have required support from the Pension Protection Fund (PPF), the industry lifeboat.
“This has seen more than a quarter of a million people facing a cut (often 10% or more) to the benefits that they were promised.”
It may sound like a leftists’ idea of an Orwellian dystopia, but L&G reckons its brand of inclusive capitalism is “improving lives by boosting the economy from the ground up”.
It does sound good for all parties- policyholders get peace of mind, trustees get expensive obligations off their balance sheet, and L&G earns a pretty penny on margin.
L&G also espouses the socially conscious investments it makes into clean energy and urban regeneration.
Shareholders are also in on the party- L&G today said it anticipates delivering higher shareholder returns (presumably via dividends or buybacks) thanks in part to its strong pipeline of PRT deals.
The show will keep on keeping on going, unless we suddenly find the key to eternal life.