Longevity swap to bulk annuity a viable pension de-risking approach: Aon


Moving from longevity hedging, through longevity swaps and other insurance or reinsurance instruments, to a full bulk-annuity buy-in, is now a viable approach to pension fund de-risking, according to Aon Hewitt.

On the back of the first unwinding of a longevity swap, which saw UK closed life and pension fund consolidator Phoenix Group transform the insurance terms of its longevity swap into a £1.2 billion annuity arrangement with the help of Aon Hewitt, this approach to moving up the de-risking scale is now considered more viable.

Aon Hewitt says that beginning to de-risk a pension fund with longevity hedging products can be a viable stepping-stone on the path to a full buy-in with bulk annuities, allowing pension trustees to recognise some benefits early in the process, test the market and become more comfortable with counterparties etc.

“Longevity swaps offer a meaningful reduction in risk and a step towards later annuity purchase,” Aon Hewitt explained, but warned that the contractual fine details of the hedge must be aligned with the path towards annuity to enable easier conversion at a later stage.

“In particular, Trustees purchasing longevity insurance need to make sure that contractual provisions allow them to carry out a competitive tender and place business with a bulk annuity provider offering the most competitive price, without penalties being levied by their current longevity swap provider,” Aon Hewitt warned.

Also, Aon Hewitt says that pensions need to be aware that reinsurance capacity providers will often want the longevity reinsurance or swap protection to remain in place, in some form, with the annuity provider, so contractual provisions need to be in place to allow the switching of roles.

As such, “this is one of the key areas of focus when putting in place a longevity swap,” Aon Hewitt believes.

The adviser also warns on the potential for complexity, particularly where a longevity reinsurance arrangement has a large panel of reinsurers involved.

“There can be material financial benefit in using a number of reinsurers to support a longevity transaction. As such, the complexity associated with using more than one reinsurer needs to be balanced with any cost savings that can be achieved,” they explain.

In the case of the Phoenix deal the resulting annuity was treated as an expansion of the longevity swap, not a new re/insurance agreement, which allowed the sponsor to leverage transitional arrangements for reserving under “Solvency II”.

While it remains a complex process, having a longevity hedge in place with the right terms and contractual finery in place could make the transition to a bulk annuity simpler for pensions which have yet to de-risk, or for whom moving straight to buy-in would be deemed too complex.

Read about many historical longevity swap and reinsurance transactions in our Longevity Risk Transfer Deal Directory.

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