Analysis from PwC questions the ability and capacity of traditional reinsurers to support the potential growth of the longevity hedging market over the next few years. PwC predicts the market for risk transfer in the form of longevity swaps and hedging in the UK could triple over the next three years.
To date, PwC says that over £20 billion of longevity swaps have been transacted for UK pension schemes since the market first emerged in 2009. PwC expects this rate of issuance will grow significantly and predicts the longevity swap market could reach £60 billion by 2016.
If this forecast rate of growth for the longevity risk transfer market comes true PwC warns that the market could witness a capacity crunch. This is because the global reinsurers that take on the large volume longevity swap risks are increasingly filling their capacity and/or beginning to focus on other countries where defined benefit pension provision is also prominent but deal sizes are bigger.
This could mean that reinsurers interest in UK longevity swap deals may wane which could lead to an increase in the price to hedge longevity. Competition from reinsurers keen to assume longevity risks has been one of the factors which has helped to reduce the costs to transaction longevity swaps in recent years.
Paul Kitson, pensions partner at PwC, commented; “While many UK pension schemes are actively considering longevity hedging as a key way to reduce risk in their schemes, many have been holding back on deals to see how the market and pricing develops. This may be a risky strategy as the market for longevity hedging deals could be heading for a capacity crunch. At least one reinsurer has already used up over half of its capacity for these types of risks and others are directing their resources to the US, Canada and other markets where deals could be much larger, leaving reduced appetite for UK deals.”
The UK market for longevity risk has been one which has driven the development of longevity hedging in recent years. However the potential for the market is seen to be much larger in the U.S. and other countries where pension schemes are significantly larger and the opportunity for reinsurers could, as a result, be much greater.
Kitson continued; “The geographical origin of longevity risk is of less importance to global reinsurers, so while the UK has passed significant pension scheme longevity risk to reinsurers in recent years, the UK does not have a monopoly on reinsurers. Defined benefit pension plans in other countries are now looking at similar transactions meaning potentially less capacity for UK deals.”
Still, the UK market for longevity hedging has a long way to go itself, as Kitson explained; “The £20bn of longevity swaps already written in this market is only the tip of the iceberg given the £1.5trn of private sector defined benefit pension liabilities in the UK. We are already seeing the first signs of reduced competition, meaning UK pension schemes that take too long to take advantage of longevity hedging could be left facing limited options and potentially higher prices.”
The amount of longevity risk in the world’s pension schemes is enormous and an eventual capacity crunch in the market for longevity hedging is almost a certainty, as the amount of risk is much larger than the world’s reinsurers can assume alone, unless a way to pipeline these risks to capital market investors in a palatable format can be developed. There is still significant interest in longevity trend bonds and longevity risk insurance-linked securities (ILS) if only the market can work out a way to encourage investor and sponsor interest in these deals.
A capacity crunch for the UK’s pension funds, because reinsurers look elsewhere for more deal-flow, could be headed off if a liquid market for longevity risk transfer can be developed with the support of the capital markets. However, the potential crunch the UK faces will be nothing compared to the crunch the world’s pension funds would face once reinsurers become over-exposed to global longevity trends, a real possibility while a pipeline to retrocessionally pass longevity risk on to capital markets investors does not exist.
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