26 Sep 2023 2 min read

Constructing buyout-ready portfolios for the endgame

By John Southall

As defined benefit (DB) schemes adopt a holding pattern ahead of a potential buyout, our Solutions team – making use of their modelling frameworks – share their insights into how they believe schemes can best invest to meet their objectives.


DB: Approaching an inflection point

With dramatically improved funding levels, thanks in large part to the significant rise in gilt yields over the past 18 months alongside a partial recovery in risk-asset prices, the DB market is approaching an inflection point. The demand from schemes that are already – or soon will be – in surplus on a buyout basis is a multiple of the annual capacity of the pension risk transfer (PRT) market.

To put this in context, The Pensions Regulator estimates that over a quarter of all DB schemes could now be more than fully funded on a buyout basis[1], which could amount to £350bn of demand versus an estimated annual pension risk transfer market capacity of around £60bn, according to estimates by LCP[2]. Indeed, the volume of insurance policies that insurers may be able to write each year feels like a rounding error when it comes to the c.£1.4 trillion of DB pension scheme assets[3], given that over 75% of schemes have now recognised buyout as their likely ultimate end state[4].

In addition to the capacity constraints, there are two further reasons why schemes may be unable to buy out in the near term:

  • Data issues need to be sorted – records must be complete and accurate
  • Illiquid assets in the scheme that insurers won’t accept as payment, or will only accept with a hefty haircut, need to be run off or sold

While many pension schemes therefore are, or soon could be, fully funded on a buyout basis, they may not be able to transact immediately. As a result, we’re likely to see schemes adopting a holding pattern as they prepare for a potential buyout. The fundamental question is therefore: How should schemes invest as they approach their buyout endgame?

In this paper, we discuss some of the options available to schemes, and present a quantitative modelling framework that can help inform schemes as they consider their DB endgame strategy.

We find that buyout-ready strategies are scheme- and belief-specific but normally might opt to have high interest rate and inflation hedge ratios, a sizeable allocation to investment-grade public credit and, in many cases, other diversifying sources of excess return potential.

Please read our full paper on constructing buyout-ready portfolios for the endgame.


[1] Source: TPR Annual Funding Statement 2023

[2] Source for figures: Insurance enters a new phase – a skyrocketing market | Lane Clark & Peacock LLP (lcp.com)

[3] Source: PPF 7800 index as at 31 July 2023

[4] Source: Hymans Robertson Risk Transfer Report 2023


John Southall

Head of Solutions Research

John works on financial modelling, investment strategy development and thought leadership. He also gets involved in bespoke strategy work. John used to work as a pensions consultant before joining LGIM in 2011. He has a PhD in dynamical systems and is a qualified actuary.

John Southall