Private Equity Sees an Oligopoly Ripe for Disruption

When private equity firms push into an industry, you know there are decent returns to be made. Just consider their enthusiasm for the arcane business of insuring corporate pensions.

A company’s retirement liabilities are a nightmare for the chief financial officer. They’re an imprecise long-term debt, introducing volatility to the company balance sheet. Regulation discourages investment in higher-returning assets like equities that would help pay the pension obligations when they come due. Hence CFOs are desperate to offload the burden to anyone who will take it on. The insurance industry is happy to oblige – for a fee.

The situation is exemplified in the plight of Walgreens Boots Alliance Inc. The US pharmacy chain has been struggling to sell its UK Boots subsidiary. The pension plan was likely deterring suitors. Last month, Walgreens transferred the liability to Legal & General Group Plc. The transaction valued the burden at £4.8 billion ($6 billion), making it a record deal for the UK insurer. L&G receives the plan's investment portfolio, but Walgreens also agreed to inject another £500 million and accelerate £170 million of top-up payments already committed. Think of Walgreens as paying a fat fee just to have the chance of turning one of its core operating businesses into cash.

The high price of such pension transfers had hitherto put them out of reach for most corporations. But deals are becoming more affordable. Rising interest rates reduce the accounting value of retirement liabilities, in many cases cutting pension deficits (a shortfall in assets matching the obligations). So insurers are now charging lower premiums to take on underfunded plans. The UK market is expected to see particularly strong growth, with deal flow set to exceed £50 billion annually in the coming years, potentially touching £70 billion, according to consultants Hymans Robertson.

This surge in demand meets a small number of insurers capable of the underwriting. Regulation creates high barriers to entry in terms of capital and expertise. Just four players — L&G, Phoenix Group Holdings Plc, Aviva Plc and Pension Insurance Corp. — have 74% of the market, according to consultants Lane Clark & Peacock. It looks like an oligopoly.

Concentration Persists Even as Competition Increases