Pension fund trustees and sponsors are increasingly focused on accessing sources of longevity reinsurance capacity as directly and efficiently as possible, promising to stimulate further growth of the longevity swap market in 2015, according to Aon Hewitt.
The pensions and benefits consulting division of insurance and reinsurance broker Aon expects that 2015 will be a year of “significant growth” for the market in longevity swaps and hedging, as pension funds continue to look to transfer their longevity exposure to others.
As a result of growing demand for access to longevity risk transfer and reinsurance capacity, the search for efficiency is set to continue, Aon Hewitt says, with structures that allow more direct access to reinsurers growing in popularity.
After a record-breaking 2014, which saw a significant volume of large longevity swap and reinsurance transactions completed, as well as a number of smaller deals, Aon Hewitt expects that reinsurance capacity for longevity risks will continue to expand, keeping up with the growing demand from pension funds.
In its annual review of the pension risk settlement market, Aon Hewitt discusses the trends witnessed in longevity swaps and reinsurance in 2014 and looks ahead to the prospects for the market in 2015.
One of the points highlighted is that pension funds are looking for ways to make the transfer of longevity risks more efficient, cost-effective and to get closer to the ultimate bearer of their risks, the reinsurers themselves.
That means that alternative structures are becoming more popular, which should see a continuation of the trend that began in 2014 involving pension funds either establishing their own insurance captive vehicles, to then transfer risks to reinsurers, or using facilities that have been established to allow more direct access to capacity. Observers have suggested that this trend can as much as halve transaction costs.
This will result in more focus on longevity hedging solutions for smaller pension funds, the sub-$400m scheme size, this will make mid-market longevity hedging a “viable option”, the broker explains.
Innovative solutions will be sought to “bridge the affordability gap” making entering into longevity transactions more achievable for smaller pensions, hence efficiency is key to cut costs, reduce friction and get the sponsors closer to the ultimate reinsurance capacity.
There is a continued focus on understanding and managing longevity risks at pension funds, especially across Europe, Aon Hewitt explains. As schemes come to terms with what their exposures mean for them it will result in greater interest in completing transactions.
Aon Hewitt’s report explains; “The longevity market continues to develop apace, for both smaller schemes (with new simpler solutions emerging to make access to the market possible) and for ‘mega’ funds (where clients are seeking to find their optimal balance between the price of hedging longevity risk and their exposure to counterparty and regulatory risk).”
2014 was “A year of innovation, with clients increasingly looking to explore alternative structures to access the reinsurance market via the most efficient route possible,” Aon Hewitt continued.
Capacity is not an issue, Aon Hewitt believes, with further growth in appetite expected among the key reinsurers that target longevity risks.
“Reinsurance capacity remains significant with over 15 market participants all of which have increasing appetite to do business,” Aon Hewitt says.
“We are continuing to see interest from more than 10 reinsurers on most deals, each with £0.5 billion or more of capacity – and in some cases several billions to put to work. The significant capacity in this competitive market allows deals to be done on attractive terms – even for the multi-billion ‘mega-deals’,” the report continues.
Changes in the UK budget, which resulted in a decrease in the number of individual annuities written means that reinsurers have more capacity available for longevity risks from defined benefit schemes.
“This is good news for pension schemes, as reinsurers seek to replace the longevity risk they were expecting to take on from the individual annuity market with longevity risk transferred from DB pension schemes and insurers in the bulk annuity market – offering a more competitive market and attractive terms,” the report explains.
“With the increased capacity we are currently seeing in the market, we are expecting 2015 to be a bumper year for the longevity swap market,” Aon Hewitt forecasts.
And this will not just be for the very large pension funds, the barriers to entry continue to drop making longevity reinsurance accessible to much smaller pension schemes.
“We are seeing continued appetite from sub-£400 million schemes to hedge longevity risk. This, combined with the development of cost-effective solutions in recent months, means that we anticipate 2015 will be the year that longevity hedging becomes genuinely accessible to schemes of all sizes,” Aon Hewitt explains.
However don’t expect pension funds to begin directly transacting with reinsurers, warns Aon Hewitt, the need for intermediary solutions remains key.
“‘Direct reinsurance’ is theoretically an option, whereby the scheme enters into a contract directly with a reinsurer. In reality, this is currently unlikely to be an appropriate solution, as there are insufficient reinsurers willing and able to do this (with the necessary UK insurance licences), to provide meaningful supply/competitive price tension,” the report explains.
Based on the currently available market capacity and pricing Aon Hewitt expects 2015 will be a year of growth for longevity swaps. If capacity is also set to rise, as reinsurers continue to show appetite to assume longevity risks, the year could see another record for transaction volume.
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