Eurozone crisis could close off longevity risk transfer opportunities

Opportunities for pension schemes who are looking to transfer longevity risks through the use of instruments such as longevity swaps or annuities, could become closed off due to the Eurozone crisis, according to a new report from Towers Watson. The report which details the results of a survey of several major providers –  insurance companies and investment banks, also suggests that the Eurozone crisis could create new opportunities but pension schemes will have to be prepared to take advantage of them.

The survey includes responses from leading providers of pension risk transfer services including Aviva, Deutsche Bank, Lucida, MetLife, Pension Insurance Corporation, Rothesay Life and Swiss Re, who all contributed their thoughts on the state of the risk transfer market and how it might develop. Key tips from the respondents for pension schemes looking to enter into risk transfer deals include making sure that trustee and corporate objectives are aligned, appointing experienced advisers and establishing clear triggers for action. Ben Stone, a senior consultant at Towers Watson said; “De-risking transfers have to be approached like M&A activity: make sure all parties have the finance in place to do the deal and remember this is a negotiation leading to completion, not an interesting discussion.”

The Eurozone crisis has a clear impact on pension scheme funding levels and also on the prices of transactions such as annuity and longevity swaps. This makes it imperative that schemes looking to transact are prepared to do so quickly, else the pricing could change.

Some key insights from the report include:

• Schemes with bigger deficits will usually have to retain some risks for longer. However, strong demand for liquid assets allows trustees holding gilts to sell them and buy annuities at lower cost.
• There will be windows of opportunity as volatile market conditions cause providers’ prices and schemes’ asset values to move around. But there is also more danger that prices will change before a transaction is complete.
• Providers could increase prices if they start expecting more defaults on the assets they hold to back annuity commitments.

Ben Stone added; “The latest blow to scheme funding levels has made full buyout a more distant prospect for many schemes. However, this cloud has a silver lining: buying in annuity policies to cover existing pensioners can be more affordable for those who have seen the value of their gilts outpace the rise in annuity prices. Market turbulence will open doors then quickly slam them shut, so schemes need to work with providers to accelerate the completion of transactions and lock down the price in the run up to the trading day.”

Recently the larger transactions in the pension risk transfer space have been for longevity risk only, and Towers Watson think this trend is likely to continue. Smaller pension schemes tend to deal with longevity risk as part of a bulk-annuity type deal, where as the larger schemes prefer to enter into longevity swaps specifically to offload that risk, acquiring annuities separately if needed.

The report contains many insights from the providers on mechanisms to transfer risk from pension schemes. On longevity waps specifically the report says that potential buyers of swaps need to look ahead and keep an eye on the market as capacity is largely driven by a small group of parties willing to take on the risk. As capacity is taken up prices could increase and schemes could risk being shut out of the market.

Providers also said that they expect longevity swaps to remain the domain of larger pension schemes for the moment given the lack of historical data that some small schemes have and the fact that longevity swap contracts can be extremely complex.

On the capital markets, the providers said that any willingness from capital market investors to take on longevity risks could lead to more competitive pricing and innovative contract structures. The aspiration, they said, must be to create simple, flexible, good value products which are supported by a material supply of capital – possibly facilitating longevity protection across a scheme’s whole membership rather than just pensioners.

The report also contains a number of case studies on transactions which are of interest. You can access the full report on the Towers Watson website.

The graph below taken from the report shows the growth of the pension risk transfer and longevity risk transfer market.

Pension risk transfer by year