The key de-risking tools
Insurers have developed a range of tools to allow pension plans to de-risk. There are three main options available to pension plans in this market – either a buy-in or a buy-out from an insurer, or a longevity swap from an insurer or a bank.
1 Shortfall paid either immediately or crystallised into a series of regular known payments 2 Diagram shows position just before issue of individual member policies
Highlights of 2011 – longevity swaps Longevity swaps accounted for £7.1 billion of the £12.3 billion of business in 2011 as large pension plans (ITV, Rolls Royce, Pilkington and British Airways) entered into transactions in the second half of the year. This allowed them to transfer large volumes of longevity risk to providers without needing to disinvest the underlying assets in volatile markets. The providers passed on a proportion of the longevity risk to reinsurers.
Legal & General wrote its first longevity swap in 2011, offering an alternative provider to pension plans considering hedging longevity risk.
Highlights of 2011: buy-ins and buy-outs Volumes of buy-ins and buy-outs increased over the second half of 2011, culminating in two “mega-deals”: Turner & Newall at £1.1 billion in October 2011 and Uniq at £830 million in December 2011. These two plans faced the additional challenge of needing to co-ordinate insurer negotiations with assessment by the PPF. Both plans were able to secure benefits at least as great as those provided by the PPF, by locking into favourable movements in asset values relative to insurer pricing. Pricing was particularly competitive in the fourth quarter, driven by strong competition for business and favourable investment opportunities available to insurers, for example from high-quality corporate bonds.
Pensioner buy-in pricing The competitive pricing in late 2011 created a particular opportunity for pension plans holding UK government gilts, whose value rose significantly relative to the cost of buy-in. This led to a double benefit – the gilts provided protection from rising liability values and gave pension plans an opportunity to take advantage of the best pensioner buy-in pricing relative to gilt values since 2008. This convergence in pricing can be seen in the chart below.
Longevity swaps: a renaissance? After a quiet 15 months, the second half of 2011 saw four longevity swap transactions covering £7 billion of liabilities. Is this the sign of things to come? Longevity is a key risk for UK pension plans. Over the past 20 years, male life expectancy has increased by nearly five hours every day.
The three key drivers for continued growth in longevity swaps are:
- reducing the complexity of the products, particularly with regard to collateral arrangements;
– providing a more streamlined transaction process – particularly where back-to-back contracts with reinsurers are required; and
– increasing the capacity of the longevity risk market by widening the number of ultimate holders of this risk, either through additional reinsurance or capital markets.