The use of longevity hedging instruments, such as swaps and reinsurance, is expected to grow in 2016, with longevity risk increasingly on the agenda for pension funds, while reinsurer appetite for assuming longevity risks remains strong, according to Willis Towers Watson.
One of the signs of a healthy market in longevity swaps and risk transfer has been the availability and affordability of reinsurance capacity. Reinsurer appetite for assuming longevity risk has been strong and growing, keeping longevity risks largely out of the capital markets in recent years.
Many large reinsurance firms remain over-weighted towards mortality risks, the risk that more deaths occur than forecast, meaning that assuming longevity risk as a natural hedge and balance to that mortality exposure has been increasingly attractive.
By assuming and underwriting longevity risk, to balance the mortality exposure, reinsurance firms can optimise their capital use and lower reserve requirements, overall. Hence the appetite among reinsurers and large life insurers has been strong and driving the growth of the longevity risk transfer market.
That growth is expected to continue in 2016, with forecast that £20 billion or more of longevity swaps will be transacted in 2016, despite a slower start to the year.
Shelly Beard, senior de-risking consultant at Willis Towers Watson, explained; “The prominence of longevity risk on schemes’ agendas means that we are expecting to see continuing growth in longevity swap markets. 2014 saw deals covering £25bn of liabilities, including the record breaking £16bn hedge for the BT Pension Scheme. This flow of deals continued in 2015 with AXA, Heineken and a further deal for Aviva – some £6bn of liabilities.”
£20 billion or more of UK sourced longevity hedging in 2016 would be the second biggest year on record for the market. For the moment longevity risk transfer remains largely a UK and Netherlands phenomenon, with a few transactions seen in Canada and other European countries. Interest is growing in the U.S. and once that market recognises the risk of pensioners living longer and the additional liabilities that results in, its pension market is also expected to see some activity.
“Based on the conversations we are having with our clients, it is likely that 2016 could see longevity-hedging deals covering over £20bn of liabilities. The range of structures available for accessing the demand for longevity risk in the reinsurance market means that longevity hedging is more affordable and flexible than ever,” Beard continued.
It is this strong demand for longevity risk from reinsurance companies that makes it a good time for pension funds to be looking at ways to offload their longevity risk. With more options available than ever before, transaction costs cheaper, more efficient structures available and more experience among brokers and facilitators, the longevity risk hedging market seems destined for growth.
Willis Towers Watson warns that demand for longevity reinsurance capacity could also rise, thanks to the new Solvency II capital requirements. Bulk-annuity providers may find themselves compelled to look to transfer out longevity risk, through swaps and reinsurance, in order to improve their capital positions.
This increased Solvency II driven demand for longevity reinsurance capacity could result in capacity and resource constraints, potentially meaning that “pension schemes find it more difficult to get traction when reinsurers have limited resources,” Willis Towers Watson explained.
However Beard said that any impact to the market is expected to be minimal, explaining; “Reinsurers are aware of the potential capacity constraints and are continuing to build their teams to cope. While we may see bottlenecks in certain areas, we do not expect it to have a major impact on the market and schemes that go to market with clear objectives will continue to achieve good outcomes.”
The potential for the longevity risk transfer market is clear, with exposure to longer lives a major risk for pension funds in the UK and elsewhere.
“There are £2 trillion of UK defined benefit (DB) liabilities and to date only £150 billion of these have hedged longevity risk. This is an area that continues to grow rapidly both in terms of the size and volume of annuity transactions and longevity swaps, with more innovative ways to access this market being developed,” Beard continued.
The market continues to discuss the need for longevity risk to be transferred in a liquid and tradable form, but longevity swaps and risk transfer transactions remain largely traditional, tapping the world’s largest reinsurers and life insurers for most of their capacity needs.
However, with activity expected to continue to be brisk there is an increasing chance that the capital markets will get their moment in longevity hedging. A number of ILS managers remain open to participation in longevity swaps and hedging, but opportunities continue to be scarce as traditional re/insurance firms soak up the bulk of any deal-flow.
Beard suggests that market growth is likely to continue; “With more and more pension schemes starting to think about a de-risking journey and how to manage their risks, the activity in this market is only expected to increase as longevity risk moves higher up the agenda for pension schemes.”
The expectation that deal sizes will continue to shrink remains, a trend we’ve been covering for a few years now. The efficiencies gained in recent years are helping pension funds to transact in smaller deals more cost-effectively, opening the doors to much smaller pension plans to hedge their longevity risk.