Back in the 2008 when Reinet Investments (RNI) was formed, most of its net asset value (NAV) was made up of British American Tobacco (BTI). While the tobacco giant still makes up about a quarter of Reinet’s NAV (Figure 1), the investment holding company’s major exposure is now the Pension Insurance Corporation (PIC) – see their investors website here.
Figure 1: Reinet’s current Net Asset Value Breakdown
Sources: Reinet disclosures, Refinitiv & Integral Asset Management workings
For an investment that makes up half of Reinet’s NAV, there seems to be surprisingly little excitement out there about the PIC. I can only assume that this is due to the lack of understanding and, thus, let me break down the basics of why the PIC is an exciting investment.
The PIC operates in the UK Pension Risk Transfer (PRT) market. While I am pretty sure readers are familiar with the UK, the PRT market needs some explanation.
Historically, pension funds were structured with defined benefits (irrespective of contributions and investment performance, the pension guaranteed pensioners a fixed pension income) and managed in-house by the companies that employed the staff. Because no one except pension companies are experts in managing pensions and because the world and, thus, returns are an uncertain thing, most pension fund setups are now defined contribution schemes (pension income is now dependent on lifetime contributions and investment returns) and probably either outsourced to a specialist pension fund operator or lumped into an umbrella scheme with other employees from other companies.
The reality is that defined contribution schemes shift market and solvency risk onto the employees and leave businesses free(er) to operate without these liabilities.
Yet, particularly in the UK, many older companies have legacy defined benefit schemes that are still in place, having to be honoured, and still sit on their balance sheets.
Hence, we have the Pension Risk Transfer (PRT) market where PRT insurance companies offer these businesses one of two solutions to take the risk off their balance sheet:
- Pension buy-in: The pension buys a bulk annuity insurance policy to (perfectly) cover its liabilities to (some or all) scheme members.
- Pension buy-out: The pension sells the assets and liabilities along with the attached scheme members and then (probably) winds itself up.
In both these cases, the pension (i.e. the company whose responsibility this is) is transferring the risk of the net liabilities in this scheme across to someone else. I.e. The pension risk is being transferred, and, hence, the name: PRT.
Whether a pension buy-in or buy-out, the PRT transaction typically has the insurance company value the current and expected (net) liabilities and arrive at a “price” (that includes a good insurance margin) that the company pays them for the insurance company to assume the pension’s risk.
In a strange way, this is almost like an asset management company where instead of investors, they have are paid by others to takeover (pension) liabilities. The trick is that they then have to invest this aggregate float to outperform these liabilities as they fall due. Any investment outperformance against these pension liabilities accrues to them and compounds into their profits and their own NAV (remember, defined benefit means that the market risk and returnaccrues to the manager of the scheme, not the member).
The PIC is exactly this, and why am I excited about it?
Well, the regulatory, scale, knowledge and capital barriers of entry to this market are large. You need the licenses, you need to operate pension schemes with members and, thus, need a scalable administrative setup (the PIC currently administers 339,900 policyholders!), you need to know what you are doing (both in pricing the risk and managing your investment portfolio) and you need a large pile of capital (the PIC has a portfolio of £44.9bn). Thus, there are only a handful of players in the UK market in this space.
And then there is the growing demand… The world is getting more complicated: market volatility is rising, UK gilts (i.e. bonds) and other supposedly safe assets are crumbling while inflation is rising and regulatory burdens intensifying. In other words, the world is getting riskier and more companies (whose core business is not managing pensions) with defined benefit liabilities on their balance sheet are wanting to take the risk and hassle out of their lives. In fact, the PIC estimates that the UK market has c.£600bn of defined benefit schemes looking to transact and their own pipeline has risen to over £50bn!
Anecdotally, I recently had dinner with an executive team of a UK small cap that was in town and while discussing their business we dug into their defined benefit pension scheme on their balance sheet. While not their core business, this is a constant worry for them. When I asked them about getting rid of it via PRT, they said that they would love to do this but they need to save up sufficient capital to do so…
The pricing power has swung in favour of the handful of UK PRT players and, given the size and attractiveness of the market, I do believe that the Pension Insurance Corporation is Reinet’s hidden giant. And, then there is the fact about how conservatively Reinet values this wonderful business in its own calculation of NAV coupled with the large discount that Reinet’s share trade against this conservative NAV…
ORIGINAL ARTICLE APPEARED ON MONEYWEB