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Offshore captives ideal for longevity swaps and reinsurance


The establishment of a captive insurance entity for longevity swap transactions in an offshore domicile presents significant cost reductions and a beneficial operating environment for market participants, according to industry experts.

The international longevity risk transfer market has witnessed impressive growth in recent times, underlined by the increase in frequency and size of longevity reinsurance transactions.

Further evidenced is the growing ability of re/insurance and insurance-linked securities (ILS) domiciles to attract the establishment of captive insurers to provide pension schemes with more direct access to reinsurance capacity to hedge their exposures.

Head of Towers Watson’s transactions team with a specialist focus on advising pension funds and sponsors on hedging longevity risk, Ian Aley, recently highlighted the benefits of creating a cell company for pension funds’ de-risking purposes.

“The appetite for longevity is in the reinsurance market, so you could use an insurer to take the risk and then pass it on, but they will have to apply capital to that risk, even though they are not writing the risk. If you use a captive offshore, such as Guernsey, the capital regime is different and there is a greater level of relief from reinsurance,” said Aley.

Utilising an offshore captive insurer, or cell company, offers significant cost reductions for large-scale pension schemes seeking to hedge some, or all of their exposure, notes Aley, eliminating the need for advisory and transactional costs tied to intermediaries.

The removal of an intermediary also guarantees a ‘principal-to-principal’ relationship between the pension fund and the reinsurance market, explains Aley, “rather than have a third party influence documentation and the terms of the contract.”

Something Aley feels emphasises the notion that a captive insurer for longevity risk transfer “better suits the needs of both parties.”

A captive insurer would enable the pension scheme to maintain greater control during a longevity deal, dealing directly with the reinsurer increases involvement, understanding and significantly reduces costs, as mentioned previously.

Typically, adds Aley, traditional insurers acting as intermediaries have numerous product lines and business lines to consider, from past and future transactions, something that can hinder the their willingness to partake in large-scale, or high exposure longevity reinsurance deals.

Aley continued; “Consequently, they are restricted in terms of the level of credit exposure they are willing to take to a reinsurer. So, in reality, if you’re doing a transaction of scale, you’re now looking at an average price rather than the optimal price.”

Aley’s insight and opinions on the use of captives for hedging longevity risks was heard during a panel session titled, ‘Longevity – is there a life in captives?’ an event hosted by Guernsey Finance. Other panellists included John Dunford of the Guernsey Financial Services Commission (GFSC), Philip Jarvis of Allen & Overy LLP, Paul Kitson from PwC, and Andy McAleese of Pacific Life Re.

A ‘big driver’ in the rise of pension funds seeking to hedge their longevity exposure is the potential impact rising life expectancies has on their balance sheets, explained Kitson. Adding that in the last decade roughly £200 billion has been added to the liabilities of pension funds, further highlighting the opportunity for reinsurance and even ILS to participate in the burgeoning longevity swap market.

“Some of that of course, is catching up, perhaps, and putting more forward-looking modelling around what’s going to happen in the future and future improvements, but clearly one of the reasons why this risk is now regarded as one of the big risks is the fact that it has contributed significantly to liabilities in the past,” explained Kitson.

Continuing to stress that currently, and more so in the future pension funds and sponsors are developing and utilising greater analytics and analysis to asses and better predict the potential impact of longevity risks on their balance sheets.

Guernsey has had success in the past with the establishment of such entities and it’s likely that as the market continues to expand it will be a growth area for the domicile moving forward.

John Cole, Head of Operations for the BT Pension Scheme, which was involved in the largest ever longevity reinsurance transaction in the market’s history, a £16 billion longevity swap deal between BT and The Prudential Insurance Company of America, gave some insight into why the incorporation of a captive insurer in an offshore domicile is appropriate for this kind of risk transfer.

“The regulator and all of the companies in Guernsey recognise the business activity. They understand the risks and that is very helpful. Guernsey is open for quality business. From our particular experience we have met and now use a number of very experienced and talented people with both insurance and captive knowledge and they have been very adaptable and flexible in helping us to land what was quite an innovative transaction for the scheme, to actually create its own captive, certainly in a transaction of this size,” said Cole.

Read details of many recent longevity swaps, longevity reinsurance and longevity risk transfer transactions here.

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