About £16 billion of UK pension schemes liabilities have had the longevity risk removed by bespoke pensioner longevity swaps in the last three years. These schemes included those of BMW and Rolls-Royce in deals that have typically involved tens of thousands of members and over a £1 billion of pensioner liabilities. However, if longevity swaps are to become a normal part of the de-risking toolkit – as liability driven investment has in the last eight years – they need to become available for schemes with pensioner liabilities of around £50 million. There is clearly demand from schemes of this size as a mid market survey to be released (of schemes with assets of less than £500 million) showed that over 20 per cent of them expect to have some form of longevity protection in place within the next three years,
Historically in the UK the only choice for a midmarket scheme which wanted to remove longevity risk was to buy-in. This is currently a solution if the scheme has already matched some or all of its pensioner liabilities with gilts. At market prices at the end of December 2011, schemes could hand over its gilts to a provider and they would take on the bundle of risks including longevity – a much improved liability match and often at no additional cost. This is possible because insurers are using some of the excess return they expect to achieve from investing partly in corporate bonds to offset the costs of the other risks like longevity. If schemes are reasonably close to a transactable price but not quite there, then consider pre-agreed pricing triggers. The trustees of the TI Group Pension Scheme was recently advised on a £150 million pensioner buy-in where the client had identified a specific basket of gilts they wanted to use to pay the premium. The advisor set up daily pricing monitoring and made sure the contract was ready to go, so that when the price hit the value of the basket of gilts the transaction could complete the same day.
If schemes are investing in riskier assets than gilts for your pensioner liabilities, and the scheme funding basis makes allowance for out-performance from those assets, then the cost of a buy-in can look expensive relative to the value of the liabilities. The idea of passing across significant assets to an insurer if the scheme has a sizeable deficit may also be unappealing. But a mid-sized scheme can now consider removing longevity risk in isolation. For example, Pall undertook an index based transaction with JP Morgan for £70 million of liabilities in February 2011. However, it is interesting to note that other schemes have yet to follow this lead, and this is not generally an appropriate solution. More excitingly for mid-market schemes, one provider announced this January that it could make bespoke pensioner longevity-only transactions available for deals from £50 million of pensioner liabilities and upwards.
Is demand there?
Given that the demand is there for longevity risk removal and the supply side is developing new products, if these two can meet in harmony then one should expect the development of a market of £5-10 billion of longevity risk settlement transactions in the UK from schemes with assets of less than £500 million in the next one to three years. Whether these are primarily buy-in transactions or longevity swap transactions will depend on where schemes have reached on their de-risking journey.
Buy-in The purchase of annuities from an insurer as a buy-in, bundles up the removal of longevity risk with the removal of many other scheme risks including interest rate risk, inflation risk, investment risk, etc.
Longevity swap Bespoke pensioner longevity swaps exchange a fixed series of cashflows for a series of cashflows that vary with the longevity of the members thus matching the benefits paid. Index-based longevity swaps are based on a population typically of the whole country and are not specific to the scheme members.