Activity in the pension fund de-risking and longevity hedging market, including use of instruments such as longevity swaps, longevity insurance and reinsurance, is expected to surge, according to Towers Watson.
Interest in de-risking and longevity swaps, as well as the availability of reinsurance capital, reinsurer appetite to assume longevity risks and the increasing ability to conduct smaller transactions, are all expected to contribute to continued market growth.
However, more deals doesn’t necessarily mean growing the total deal value, and Towers Watson warns that deal value in 2015 may struggle to surpass that seen in 2014.
Towers Watson also warns that while there is currently significant capacity in the global reinsurance markets for longevity risk transfer deals to tap into, it would not take many large transactions for this to change and for reinsurers to reduce their appetite to take on longevity risks.
Ian Aley, head of transactions at Towers Watson, commented; “We are noticing a big increase in the number of pension funds who want to de-risk their liabilities in the next 12 months. The practice has become more established over the last few years and with strong demand from insurers and reinsurers, prices are attractive, making it a good time to secure a deal.
“Last year we saw a record £35bn of liabilities hedged as well as the largest ever single transactions for both longevity swaps and bulk annuities. This pushed the total value of deals up to a level we do not anticipate seeing this year. Instead 2015 is likely to be characterised by an increase in small and medium-sized deals taking place as innovative new structures emerge providing easier and more cost-effective access to the longevity hedging and bulk annuity markets.”
Towers Watson expects to see growing use of facilities, such as its own Longevity Direct, which allow pension fund sponsors to directly access reinsurance capacity by using a cell insurer to effect the transaction. This trend led to some very large deals in 2014, as bigger pension funds could reduce their costs by not needing an insurance company counterparty for the deal.
“Accessing the reinsurance market more directly means significant savings in terms of the cost of hedging longevity and also reduces the complexity involved with these transactions. It provides another option for pension schemes keen to choose a cost effective way to hedge longevity,” Aley said. “On the bulk annuity side, combining buyouts with Pension Increase Exchange (PIE) exercises and winding up lump sums, can improve affordability. Longer term, if more members take transfers out at retirement, this should also improve affordability for schemes.
“The concept of ‘top slicing’, where a medically underwritten bulk annuity is transacted for those members with the highest liability, is a useful option for schemes with concentrations of longevity risk.”
Towers Watson notes that demand for UK longevity risk from reinsurance companies is resulting in significant competition for any transactions that come to market. In the short term, this appetite from reinsurers is expected to stimulate more interest among pension funds in entering into longevity hedges or de-risking transactions.
However, Towers Watson notes that reinsurance capacity for longevity risks is finite, often controlled by how much mortality risks a reinsurer can hold as a natural hedge for the longevity exposure.
Ian Aley said; “The current demand for UK longevity risk from reinsurers is driven by a desire to offset their existing mortality risk due to diversification benefits, so prices have been favourable for pension schemes looking to enter into longevity swaps. But we anticipate that £50-100bn of supply from reinsurers could easily be filled by pension schemes in the near future, which is likely to put upward pressure on prices in the longer term.”
In the longer term Towers Watson expects the current imbalance of supply and demand for longevity risks will become more balanced and that as a result costs of longevity reinsurance capacity will rise. That could stimulate the imbalance to balance more quickly, as pension fund sponsors seek to access the market sooner rather than later, to benefit from better pricing.
If indeed longevity reinsurance capacity gets more expensive or begins to run low it could stimulate renewed focus on developing capital markets solutions for longevity risk transfer.
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