The longevity risk transfer market, of longevity swap transactions and other reinsurance arrangements that hedge or transfer longevity risk, is particularly busy right now because of impending Solvency II regulation and the resulting capital requirements.
With the Solvency II regulatory regime for insurers and reinsurers set to begin on the 1st January 2016, companies are actively working to optimise capital and risk ratios.
Martin Bird, Senior Partner & Head of Risk Settlement at Aon Hewitt, explained to Artemis; “The focus on managing longevity risk remains strong. Solvency II regulated insurers are optimising balance sheets in light of capital requirements and the market is very busy in light of this.”
Global reinsurers are doing well out of this urge to hedge longevity risk currently, with some very large longevity risk transfer, swaps and reinsurance transactions taking place this year.
“Many UK insurers are making use of global reinsurance capacity to hedge exposures to longevity risk. This is a combination of reinsurance to support large scale bulk annuity deals (for example PIC’s bulk annuity deal with the Philips pension scheme was supported by reinsurance from Hannover Re) and deals to support existing business on the balance sheet: Legal & General, Rothesay Life and PIC have all announced reinsurance deals (with Prudential US, Pacific Life Re and Munich Re respectively) and there are also numerous deals that are not announced),” Bird continued.
The cost of reinsurance capacity has also been a driver in recent longevity risk transfer activity, with lower reinsurance rates encouraging insurers and pensions to offload their risk now.
“Current reinsurance pricing for transferring longevity risk is leading many insurers to execute deals as it is more capital efficient to hedge the risk than retain it,” Bird said.
Bird explained that the way cedants approach longevity risk transfer can differ, depending on the motivations; “In the UK, bespoke indemnity reinsurance is typically used; further afield in Continental Europe there is greater interest in simplified index structures that provide protection against tail longevity risk rather than full indemnification.
“The Aegon deals in the Netherlands are an example of this. Again, these are capital driven transactions where insurers are assessing which risks are efficient to retain and which risks are efficient to hedge.”
Where to transact is also beginning to become a factor in longevity hedging decisions, with regulatory domicile and efficiency a consideration.
“There is also growing interest in deals which seek to find the most capital efficient jurisdiction to place risk. Making use of offshore captive structures and deals with non-Solvency II regulated counterparties are all variations around this theme,” explained Bird.
But Solvency II is one of the biggest drivers for insurers seeking longevity reinsurance capacity right now, as they look to tweak their business models to an optimum level, prior to their capital requirements being determined under Solvency II.
Additionally, Lane Clark & Peacock LLP also highlighted the Solvency II linked longevity swap and risk transfer activity that is being stimulated by Solvency II and said that it expects that trend to continue.
Solvency II will “make the market place more crowded,” LCP said, meaning that pension plans will find themselves in direct competition for capacity with insurers.
“Solvency II encourages insurers to hedge more of their longevity risk. We are already seeing increased activity between insurers and reinsurers and expect this to increase further in 2016,” LCP explained.
As a result of the increased activity, longevity reinsurance capacity demand will naturally increase, with insurers using up an increasing amount of that capacity as they seek to balance their annuity books ready for Solvency II.
Could that see the traditional reinsurance market running dry, in terms of longevity reinsurance capacity? Perhaps opening up opportunities for the capital markets and ILS players to assume some of the longevity risk?
Hard to say at this stage. Large reinsurers and some insurers have significant ability to assume longevity risks, due to the natural hedge they provide to their life insurance mortality books. While that practice continues it seems the traditional market will continue to soak up the majority of longevity exposure.