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Like an admonitory digit pointing skyward, the chart of UK gilt yields stretches higher. Bad news for borrowers. Great news for the previously moribund market in annuities.
Annuities pay investors, typically retirees, a fixed income derived from gilts in return for a lump sum. It is a tricky, capital-intense business dominated by a few insurers. The biggest, Legal & General, trumpeted the pick up in annuities demand on Wednesday.
Ultra-low interest rates previously ensured no one bought annuities if they could help it. This included companies with legacy final salary pension schemes. Long-term gilt yields of about 4.5 per cent are now the highest since 2010. More businesses can afford to transfer schemes to insurers, simplifying their own finances. Some £1.2tn of assets may be available.
L&G dominates bulk UK annuities market with about a quarter of the market. Specialists Pensions Insurance Corporation and Rothesay have a fifth each.
Of late, L&G’s bulk annuity sales were roughly £7bn. This year it hit that target by the interim stage. Incoming boss António Simões will start on the front foot. Expect industry-wide bulk sales of £55bn-£60bn in 2024 says RBC.
Insurers are excited. Investors are more sceptical. One issue is that selling annuities is capital negative. Big annuity sales require regulatory capital transfers, which for L&G should be under 4 per cent of the annuity premium.
Moreover, capital is tied up for a long time. Accounting changes mean profits are spread well into the future. Long duration bets taken by the annuity provider are exposed to interest rate volatility.
This is one reason that L&G, a solid business that aspires to be seen as a private capital group like Blackstone, is viewed less favourably by investors. And some investors see the insurer as a proxy for a UK economy becalmed by Brexit.
The shares bump along at about seven times earnings. They have barely moved over five years. The upside is an impressively high dividend yield of 8.5 per cent. Given limited competition in the burgeoning bulk annuities market, this presents an opportunity.
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