According to its annual report on the pension de-risking and risk transfer market, Towers Watson says that it expects deal sizes in the longevity swaps market will continue to grow larger and that new structures for longevity hedging will emerge.
Sadie Hayes, transaction specialist at Towers Watson commented; “The expected surge in transaction sizes is driven by both supply and demand factors. The majority of the longevity risk from these large transactions, whether they are bulk annuities or longevity swaps, will ultimately end up being reinsured.”
So far 2014 has seen the largest longevity swap transaction ever to come to market, the £5 billion Aviva transaction which saw the insurer directly transact with a panel of global reinsurers. That followed a number of large longevity swap deals in December 2013, as pension plans took advantage of a strong appetite for longevity risk in the reinsurance sector.
Hayes explained; “The longevity reinsurance market is currently very competitive, with an ever-increasing number of players and the growing size of transactions that the reinsurers will consider as they become more confident with UK longevity risk. This, combined with a significant improvement in solvency levels among most schemes in the last 12 months, is providing even the largest pension schemes a credible option to materially reduce risk.”
Despite the recent appetite for longevity risk among large global reinsurance firms, Towers Watson warns that we may see capacity begin to dry up, which it says could be an issue for pension schemes wanting to transact this year.
Hayes explained; “It is not just the pension scheme transactions that will be using up capacity. The recent announcement that Rothesay Life intends to acquire MetLife will take significant market capacity, both for Rothesay Life and the reinsurance market which are likely to reinsure a significant proportion of the longevity risk on the MetLife book.”
If capacity dries up the market will become more choosy about which deals it will support, meaning that preferential terms and pricing may become available for those pension plans which have done their homework and are already prepared to enter into a transaction.
“As capacity is used, we expect insurers to become more selective about which opportunities they choose to quote on, and it will be those pension schemes which can demonstrate their commitment to a transaction that will get the attention and the best prices,” said Hayes.
Towers Watson also said that we may see more pension schemes looking to make the reinsuring of longevity risk more efficient leading to the creation of more innovative ways of accessing reinsurance capacity for longevity risk.It cites the Aviva example, where the pension scheme entered into a longevity swap with an insurance subsidiary within its group, before reinsuring it out to the market.
Towers Watson said that this approach may have wider applications than just for pension schemes with life insurance sponsors.
Hayes said; “It is possible for pension schemes to create insurance entities specifically for this purpose and although this may sound onerous, in practice these entities can be both capital and governance efficient.”
That sounds a little like establishing a special purpose insurance vehicle, or perhaps a captive insurer, allowing a pension plan to transact a longevity swap before then passing the risk onto the global reinsurance market. Perhaps the longevity risk could be securitized by the special purpose entity and the risk passed onto the capital markets in some cases as well if efficient indices, triggers and pricing can be defined.
The pension risk transfer market saw another first this week, when the largest UK pension buy-in and bulk annuity purchase was announced. Unlike in other large bulk-annuity transactions the insurers involved sought to reinsure the majority of the longevity risk immediately.
As we wrote earlier this week, the recent UK government budget changes to pensions could have a knock-on effect on the longevity risk transfer and longevity reinsurance market. The outcome of this is uncertain currently but the market may find capacity drying up quicker than expected if indeed longevity risk shrinks due to the pension regime change.
The Towers Watson De-risking Report 2014 includes views from bulk annuity and longevity swap providers on how the pension scheme de-risking transaction market will develop in the coming months. You can access a copy of the report via the Towers Watson website here.
View Artemis’ list of longevity swap, longevity reinsurance and longevity risk transfer transactions.