The Missing Invoice

A bulk purchase annuity looks like a deal between two parties: a pension scheme hands over money, an insurer takes on the pensions. In reality it involves six, and it only makes sense once you can see all six seats at the table. There sit the insurer's shareholders; the pensioners whose pensions are handed over; the company offloading its scheme; the insurer's executives; the Financial Services Compensation Scheme, the official safety net behind every UK insurance promise; and, behind that safety net, the Treasury — present twice, both as the last-resort backer of the safety net and as the author of the rules that make the whole thing pay.

This essay does one thing: it goes around the table and asks of each chair, what do you put in, and what do you take out? The answer describes one of the cleanest free rides in British finance — and a game that only a handful of institutions are permitted to play, on terms the public underwrites without ever being asked.

The pensioner: the unpaid lender

Start with the party the deal is supposedly for. After buyout, the pensioner is, in plain terms, a lender to the insurer — a lender who can never ask for the money back. Their pension is the steady, decades-long source of funding the insurer invests against, and what it invests in is roughly 70 per cent credit — corporate loans and bonds — a third of that being private, hard-to-sell assets the insurer values using its own models (the companion essay sets out how this works).

Now ask what any normal lender would demand before funding something like that: a higher interest rate for the risk, the right to inspect what they are backing, the right to walk away. The pensioner gets none of it. They receive exactly the pension they were already promised — no more — and it is precisely their inability to leave that makes the whole strategy work. They cannot cash out, cannot renegotiate, cannot start a run, cannot even see what stands behind them. Every bit of extra return their trapped money earns flows to the other people at the table. And they never agreed to any of this: the choice to turn their company pension into the funding for a credit fund was made by trustees, advised by consultants who only get paid if the deal goes through. The pensioner is not a customer of this market. The pensioner is its raw material.

The shareholder: first loss, second hand

The shareholder's official role is the honourable one: they put up the money that takes the first loss if things go wrong. The reality is thinner. As a companion essay explains in detail, much of the "capital" that supposedly stands first in line was never paid in by anyone. It is profit the matching adjustment let the insurer book on day one — on the assumption that its investments will pay off — and then count as the cushion held in case they don't. The same optimistic number does both jobs at once.

So the real money a shareholder has at risk, for each pound of pension promised, is far smaller than the headline capital suggests. For that modest stake they collect a great deal: the spread booked up front and paid out as dividends — which the biggest insurers have made the main selling point of their shares — plus the full benefit of a market taking on £40–50 billion of new promises every year. Their losses are limited twice over: once because they can never lose more than they put in, and again because much of what they would "lose" in a failure was never their money to begin with. Heads, they collect forty years of profit in advance. Tails, they hand back capital that was largely conjured by the rulebook.

The sponsor, the executive, the adviser: the service charges

Three smaller chairs collect on the way through. The company offloading its pension scheme gets to leave at a discount, because competition hands some of the matching adjustment benefit back as a lower price — so its escape is part-funded by safety margins that may or may not really be there. The insurer's executives are paid bonuses based on how much profit and new business they generate — the very numbers the matching adjustment inflates — so the people deciding how high to value the assets are paid on the profit that high valuation creates. And an industry of consultants, lawyers and bankers earns fees on every deal, which gives all of them a reason to keep the conveyor moving. None of this is wrong in isolation. All of it pushes the same way.

The FSCS: the guarantor who never sent a bill

Now the chair that makes every other chair comfortable. The Financial Services Compensation Scheme stands behind every UK annuity, in full, for life. If an insurer fails, the FSCS has to make sure the pensions still get paid — covering whatever the failed firm cannot.

Think of that as an insurance policy on the insurers. Someone has promised to cover the loss if a writer goes under — and a promise like that, covering huge sums over forty years, is worth a great deal. Anyone offering it commercially would charge a yearly premium for it, more for the firms taking bigger risks. The FSCS charges nothing up front. It collects only after a firm has already failed, by billing the insurers still standing — and if the failure is too big for them to cover, the bill passes to other parts of the industry, and beyond that to the Treasury, as happened with the banks in 2008.

This is the heart of the free ride, so it is worth saying slowly. The subsidy is the unpaid premium — not the eventual payout. A free insurance policy is worth something every year you hold it, whether or not you ever claim. So even if no insurer ever fails, the industry has been handed something valuable, year after year, for nothing. You do not need a collapse to prove the gift. The gift is the bill that was never sent. And because the cover costs the same whatever a firm invests in — nothing — it does nothing to discourage the riskiest strategy. The insurer keeps the reward for taking the risk; the safety net quietly absorbs the danger.

Here is the sharpest part. The day before buyout, the very same pension sat under a different safety net, the Pension Protection Fund — and that one does send a bill. It charges schemes every year, in advance, and charges the weaker, riskier schemes more. So the buyout quietly swaps a safety net that charges for risk for one that charges nothing. Part of what every buyout premium buys, without anyone writing it down, is a better state guarantee that the state forgot to invoice. If the FSCS charged for its cover the way the Pension Protection Fund does, that charge would come straight out of the day-one profit and the dividend. Its absence is worth exactly as much as a cash handout — it just never shows up in any account until the day it shows up in all of them.

The Treasury: the author and the underwriter

The last chair holds two jobs at once. As the underwriter, the Treasury is the ultimate backstop behind the safety net — the one whose own balance sheet absorbs a failure too big for the industry to cover, which, given that the major insurers each carry pension books worth tens of billions, means any failure that actually matters. As the author, the Treasury wrote the rules that decide how likely that day is. It was the Treasury that, in November 2022, kept the safety margin its own regulator had spent two years calling too thin, let insurers count a wider range of risky assets, and sold the whole package as a Brexit benefit — in return for the industry's promise to invest £100 billion in the infrastructure the public finances could not pay for.

Step back and the state's position is remarkable: it drafted in the insurance industry's balance sheet to fund its investment plans, paid for that by thinning the safety margin against its own regulator's advice, and stands behind whatever goes wrong through a guarantee it hands out free. The public is on both sides of the deal — enjoying the investment headlines today, carrying the risk tomorrow — and was asked about neither.

A game of ten players

Here is the final asymmetry, and it converts a critique of incentives into a critique of structure: almost nobody is allowed to play.

Running bulk annuities this way needs a set of privileges only about ten firms in the country hold. Special permission from the regulator to use the matching adjustment, granted asset type by asset type. A regulator-approved risk model, which takes years and tens of millions of pounds to build, and without which the favourable capital sums simply don't add up. The ability to create high-yielding assets in-house — the equity-release lenders, infrastructure teams and property arms that produce exactly what the machine feeds on, which is why the biggest player lends to its own building projects. And sheer size, to spread the cost of large teams of actuaries and heavy regulation across a book worth tens of billions. The club is L&G, PIC, Rothesay, Aviva and a few others; new entrants, when they appear at all, increasingly do so through private-equity-backed vehicles running the offshore version of the trade.

Competition inside the club is fierce — fierce enough that, as the regulator itself noted, every member is pushed toward the riskiest assets the rules allow, or loses the deal to a rival who will. But look at what they are competing to grab: contributions taken from people outside the club, who had no say. The pensioner cannot refuse to become the funding; the trustee decides for them. The surviving insurers' customers cannot refuse the bill after a failure; the law decides. The taxpayer cannot refuse to stand behind the safety net; the Treasury decides. An ordinary saver cannot use this kind of leverage on their own savings; a mid-sized insurer cannot get the permissions; a newcomer cannot conjure up an in-house asset machine. The privileges are closed. Only the liabilities are open to the public.

There is a name for an arrangement where a small group of licensed firms earns money from a special privilege, funded by people who cannot say no, and backed for free by the state. It is a concession — like a toll road, except the tolls are taken from people who never chose to use the road, and the cost of any disaster falls on people who never drive on it. The usual justification for a concession is that the public gets something back through a fee. Here the fee is the £100 billion investment promise — paid in press releases, on the industry's own terms, into the very kinds of assets that feed the machine in the first place. The concession pays its fee to itself.

The invoice

None of this needs a villain, and this essay has named none. Everyone at the table is responding sensibly to the prices in front of them. The problem is that two of the biggest contributions — the pensioner's trapped money and the state's free guarantee — have a price of zero. And economics has no more dependable rule than this: anything priced at zero gets used to excess.

The fixes follow straight from the diagnosis, and they are dull rather than dramatic. Charge for the guarantee: make insurers pay a yearly fee for the safety net, set higher for those holding riskier and harder-to-value assets — exactly as the Pension Protection Fund already charges schemes — so that the riskiest players finally pay for the danger they create, and the missing bill exists. Pay the lender: accept in the rules that the pensioner's trapped money is real funding, and that some of the extra return it earns should be held back inside the pension valuation for the people who cannot leave — which is, under another name, the very reform the regulator asked for and the Treasury refused. Or, if neither, then at least say it out loud: that Britain has chosen to run its private pensions as a free concession to ten firms, paid for by everyone and refusable by no one — and let that choice, for once, be defended in the open.

Until then it carries on as it is: contributions taken, fees waived, profits paid out, and the bill — if it ever arrives — addressed to the only people who were never at the table.

C.J. Marsden writes on political economy at ir35andmore.com. Companion essays — "The Overruled Objection" and "The Profession That Welcomed It" — set out the matching adjustment machinery, the Treasury's 2022 decision, and the actuarial profession's response.

Sources for verification: FSCS protection rules (long-term insurance: 100% of benefit, uncapped); FSCS funding rules (ex-post levies, class caps, recourse beyond the class); Pension Protection Fund levy rules (annual, ex-ante, risk-based); HM Treasury, Review of Solvency II: Consultation — Response, November 2022; Bank of England letter to the Treasury Committee (failure probability 0.5% → 0.6%); ABI statement, November 2022 (£100bn productive investment); PRA matching adjustment permission regime and internal model approval requirements; Bank of England research on implicit guarantee subsidies in banking (methodological precedent for valuing unpriced state guarantees).