The UK government announced changes to the pension regime which could result in significantly lower amounts of annuities being purchased as well as a reduction in longevity risks at pension schemes and life insurers.
The changes announced during the UK budget last week aim to give workers enrolled in defined contribution pension schemes more control over what they do with their pension pot come retirement. No longer are annuities likely to be the main source of retirement income for many as it becomes easier to arrange your own investments or to withdraw your pension entirely.
The result of these changes could have an impact on the growing market for longevity risk transfer. If insurers sell less annuities and pension schemes hold less longevity risk, due to pensioners effectively taking on their own longevity risk, the need for longevity reinsurance and ultimately instruments such as longevity swaps may diminish.
The announcement led to sharp declines in the share prices of insurers and annuity specialists which are considered exposed to the potential reduction in annuity sales. But the impact on the life insurance, reinsurance and relatively new longevity risk transfer market may be much wider reaching.
One of the knock-on effects of lower annuity sales and more people removing their pension pots will effectively be a drop in longevity risk in the market. Pensioners will be taking responsibility for more of their own longevity risk, which will mean lower levels of longevity risk transfer and reinsurance may be required.
Analyst Matthew Preston from Berenberg highlighted how a shortage of longevity risk could affect the life insurance and reinsurance market. Life insurers and reinsurers use longevity risk as a direct hedge for the mortality risk on their books, meaning that any reduction in available longevity risk could result in diversification issues for insurers and reinsurers.
Without sufficient longevity risk to offset the mortality risk that is held on their books, life insurers and reinsurers may of course find mortality reinsurance or mortality swaps and bonds a solution to pass on more of that risk to those better able to hold it. So while there may be a reduction in longevity risk transfer, perhaps we could see an increase in mortality risk transfer, at least initially.
Preston said that primary insurers may seek to hold a higher proportion of a shrunken pool of longevity risk on their own books, in order to hedge or offset their mortality risk exposure. This would certainly have a knock-on effect on the amount of longevity reinsurance transacted and perhaps on the creation of a capital market for longevity risk, at least until the new pension regime beds in.
Less longevity reinsurance transacted could also have an impact on life reinsurers who may find they do not have sufficient of the risk to maintain diversification of their longevity versus mortality exposures. The changes to the pension regime could also affect reinsurers appetite to take on longevity as the pipeline could slow while the changes are absorbed.
For pension schemes, if more pensioners withdraw their pension pot or arrange their own retirement investment they will effectively be holding less longevity risk as well, which could lower the amount of pension risk transfers and affect the growing longevity swap market.
Until we better understand how pensioners will react to and take up the new options presented by these changes there is no way of estimating how big an impact this could have on the market. However with the UK pension market driving much of the longevity risk transfer and longevity swap market some effect is bound to be felt.
Preston noted in an email to Artemis that the big question is whether there will be changes to the UK defined benefit pension market in future as well, where much of the longevity risk is concentrated. At this time the UK government has announced no plans to change the requirement for annuities to be purchased for DB pension schemes.
Of course there are also opportunities for life insurers here to come up with new products for retirees who don’t want an annuity. That could result in longevity risk in the market increasing again, but it will likely take time for new retirement options to be created and offered to customers.
Jonathan Howe, UK insurance leader at PwC, commented; “There is no doubt that the changes present very significant challenges to life insurers with a heavy reliance on annuity business, but many are already taking a glass half full approach. Yes, there will be losers, but opportunities exist for those who develop innovative new products and services for customers. Those who retire will still need investment options – they will need to make investment decisions, for an appropriate yield, for the rest of their lives. We believe despite short term pain life insurers can have long term gain. After all, there are thriving life insurance industries around the world without compulsory annuity purchases.”
More mergers & acquisitions in the life insurance market is also possible, said Howe; “At this stage, it remains a little too early to gauge the ultimate impact of restructuring and/or market consolidation. However, what is clear is that this announcement represents yet another key driver of likely M&A over the next 12 to 24 months within a European life market that already faces the challenge over optimal business models under Solvency II. It is clear that all firms will need to review and possibly reconsider their business strategy.”
The UK government changes to the pension regime are sweeping and some of the biggest changes seen in years. There is certain to be some impact to insurers and reinsurers, beyond the simple loss of annuity business, but how large an impact this could have on longevity risk transfer and reinsurance volumes will take some time to play out.