Solving the longevity challenge

As reinsurers gather in Monte Carlo this week, much of the talk will centre around rates and trends in property/casualty business and the forces driving this market.

As reinsurers become increasingly diversified in their books of business, there is also an increased awareness of the opportunities presented by other sectors, notably longevity risk—the chance that people will live longer than expected.

Paul Eaton, business development director at Artex Risk Solutions, is experienced in such deals, having worked on one of the most pioneering structures in this space. He says the appetite among defined benefit pension schemes to transfer longevity risk is growing. This is more than matched by reinsurers who increasingly appreciate the diversity this business offers and the fact it inversely correlates with their portfolio of term life reinsurance.

Artex Risk Solutions is a specialist in insurance management and alternative risk programmes including insurance-linked securities (ILS). Earlier this year, the firm acquired Guernsey-domiciled Hexagon Insurance PCC and the insurance division of Kane Group, both of which provide cell company and administration facilities to the ILS industry, as well as more general insurance management services.

Longevity risk has become a growing burden, particularly for closed defined benefit schemes, or final salary schemes, and risk transfer to the reinsurance market is increasingly seen as a solution to this problem.

“We are seeing reinsurers show an increasing interest in longevity risk, mostly from defined benefit pension schemes seeking solutions. These can be beneficial deals for reinsurers as it can help balance their capital model,” Eaton says.

“It’s logical that the natural home for longevity risk transfer is the reinsurance industry. For reinsurers holding significant portfolios of mortality risk, longevity risk offers the perfect hedge as well as capital efficiency.”

Reinsurers’ involvement in this market is still in its infancy but some recent deals have shown that a new cost-effective approach can be achieved through the use of some innovative financial structuring.

A pivotal moment in this market’s development was through the creation of a new type of entity, an incorporated cell company (ICC), whereby each individual cell is a single legal entity. This was used in 2014 by the British Telecom Pension Scheme (BTPS) in a seminal deal that transferred £16 billion ($20.9 billion) of longevity risk to the Prudential Insurance Company of America.

BTPS was able to use an ICC to access the reinsurance market directly without the need to pay a bank or insurer to act as an intermediary.

Eaton says that Guernsey was the perfect place for a longevity risk transaction of this type.

“Its robust legal framework, regulatory environment and deep expertise in the insurance and captives sectors meant that all parties in the deal were comfortable with the structure and framework around it,” Eaton says.

Since that early deal, the market has started to evolve, allowing companies to hedge, or transfer, their longevity risk. In December 2014, Towers Watson launched a new ICC specifically to allow pension schemes to gain direct access to the reinsurance market which was used by the Merchant Navy Officers Pension Fund to hedge £1.5 billion ($1.9 billion) of its longevity risk.

Other deals are in the pipeline. “We are working on a number of prospects at this time and we are hoping to bring one or more to completion later this year,” Eaton says.

In another important development for this market, Artex Risk Solutions, in partnership with PwC, in February 2015 facilitated the creation of Iccaria Insurance ICC Limited, an incorporated cell facility established to provide flexibility for pension schemes wishing to transfer longevity risk to the reinsurance market.

Eaton describes the facility as being a tailored and cost-effective solution for pension schemes offering them direct access to reinsurance capacity, and the freedom to select suitable service providers.

The facility is established with an independent ownership structure in Guernsey, Europe’s leading captives centre. He also stresses that Guernsey is a natural home for these types of deals and structures given the domicile’s long track record in the captives sector and, more recently, as a pioneer for longevity deals.

“The concept is to allow pension schemes to use a captive insurer that becomes their owned intermediary to access the reinsurance markets,” explains Eaton.

“Historically, insurance companies or banks would be the intermediaries but this is a much more cost-effective way of reaching the reinsurance capacity.”

Paul Eaton is business development director at Artex Risk Solutions. He can be contacted at:  paul.eaton@artexrisk.gg