Longevity risk transfer pricing and the amount of capacity available in the longevity risk transfer market is being driven by the reinsurance market and its increasing willingness to support longevity swap type deals, according to Aon Hewitt.
Reinsurance capacity for the longevity market has increased substantially over the last few years, said Aon Hewitt in its latest report on the risk settlement market, with the number of longevity reinsurance providers increasing to between 15 and 20 providers as well as the appetite they have to assume longevity risks increasing as well.
On most of the recent longevity swap transactions, where the longevity risk is ultimately ceded to the global reinsurance market, more than 10 reinsurers typically show interest in assuming a portion of the longevity risk. These reinsurers tend to have each have over £500m of capacity to put to work and in some reinsurers cases several billions of pounds.
This is good news for pension schemes looking to transfer longevity risks to third-parties, be they reinsurers or in some cases capital market investors. The reinsurers are driving market pricing and capacity for longevity risks, with the increased volumes allowing deals to be done on increasingly attractive terms even on the largest multi-billion sized longevity risk transactions.
The reinsurance market has grown increasingly familiar with longevity risk and particularly with the UK pension market which has dominated longevity swap and reinsurance markets in recent years.
As reinsurers have got more comfortable with UK pension scheme risk the terms available for longevity hedges relating to deferred members of pension plans now look more attractive, said Aon Hewitt, and it is now possible to structure a longevity swap to cover future retirees on an accurate basis. Aon Hewitt says that it expects pension schemes will increasingly explore the option of hedging older deferred members alongside their current pensioners where the liabilities in this group are sizeable enough to make the economics attractive.
One area of the longevity swap and reinsurance market that Aon Hewitt expects to see develop over the coming year is the use of captive, or other special purpose type reinsurers, allowing the largest pension schemes to more directly contract with reinsurers and avoid intermediaries costs.
This is interesting, as if pension schemes can become proficient at structuring their longevity risks into dedicated vehicles to effect the risk transfer, perhaps that is another step towards issuing the risk in new forms such as securities (like a catastrophe bond deal).
Aon Hewitt notes that this is unlikely to be a mainstream solution, but it could be an interesting part of the longevity risk transfer and swap market to watch develop over the coming years.
For the very large pension funds the focus is on how best to access capacity most efficiently to effect the transfer of their longevity risks. That means working on mechanisms to allow them to bypass intermediaries, more directly access the reinsurance markets and perhaps could result in more focus on the capital markets in future as well.
For the moment the reinsurance market appears to have plenty of capacity to absorb pension longevity risks over the next few years, meaning that the capital markets may not get much of a look in unless more index type transactions are effected. However, as the world’s pension schemes look to transfer more longevity risk the market could reach a stage where the reinsurers themselves also need to transfer risk on, with the capital markets then a much more likely source of capacity.
The role of the intermediary remains vital in longevity risk transactions for smaller pension schemes, for the moment, but in future there may be facilities and structures created to help these smaller schemes access the capacity of reinsurers and capital markets more efficiently and cost-effectively.
Another interesting though is whether reinsurers may look to supplement their longevity reinsurance capacity with the use of structures such as reinsurance sidecars. That might allow investors to tap into the long-duration risks while giving reinsurers additional capacity and a source of fee income. As we wrote earlier today, the reinsurance sidecar market is likely to keep evolving so perhaps longevity risk may be shared with the capital markets in that type of structure.