Longevity swap deals continue to grow

The volume and size of deals in the bulk annuity and longevity swap markets in the UK are expected to continue to grow this year, according to a report by Towers Watson.

2014 to date has already seen the record for the largest longevity swap smashed by the £5 billion transaction by the Aviva Staff Pension Fund and more deals of this size are anticipated.

According to its annual de-risking report, in 2014 Towers Watson expects deal sizes in the UK bulk annuity and longevity swap markets to continue growing; new structures for longevity hedging to evolve; medical underwriting to become more mainstream; and market capacity becoming tight.

Towers Watson predicts that the record for the largest bulk annuity, currently held by EMI for its £1.5 billion transaction in 2013, will be broken this year. In addition, its survey of the main bulk annuity providers confirms that the average size of transactions is to get larger during 2014, resulting in more transactions in excess of £1 billion.

Sadie Hayes, transaction specialist at Towers Watson said: “The expected surge in transaction sizes is driven by both supply and demand factors. The majority of the longevity risk from these large transactions, whether they are bulk annuities or longevity swaps, will ultimately end up being reinsured.

“The longevity reinsurance market is currently very competitive, with an ever-increasing number of players and the growing size of transactions that the reinsurers will consider as they become more confident with UK longevity risk. This, combined with a significant improvement in solvency levels among most schemes in the last 12 months, is providing even the largest pension schemes a credible option to materially reduce risk.”

After the bumper start to the year, Towers Watson suggested that competition for market capacity could be an issue for pension schemes wanting to transact this year.

Hayes said: “It is not just the pension scheme transactions that will be using up capacity. The recent announcement that Rothesay Life intends to acquire MetLife will take significant market capacity, both for Rothesay Life and the reinsurance market which are likely to reinsure a significant proportion of the longevity risk on the MetLife book.

“As capacity is used, we expect insurers to become more selective about which opportunities they choose to quote on, and it will be those pension schemes which can demonstrate their commitment to a transaction that will get the attention and the best prices.”

Towers Watson also believes pension schemes will increasingly look for innovative ways of accessing reinsurance capacity for longevity risk. It points to how the Aviva Staff Pension Scheme achieved this by transacting a longevity swap via an insurance subsidiary within its group and suggests this approach has wider application than just for pension schemes with life insurance sponsors.

Sadie Hayes said: “It is possible for pension schemes to create insurance entities specifically for this purpose and although this may sound onerous, in practice these entities can be both capital and governance efficient.”

The Towers Watson de-risking report also highlights that medically underwritten bulk annuities are becoming more important to pension schemes.

Will Griffiths, medical underwriting specialist at Towers Watson, said: “There has been significant growth in the ‘impaired’ or ‘enhanced’ individual annuity market in recent years and now these insurers are bringing their underwriting expertise to the bulk annuity market. The key difference between these markets is that the members do not have the potential to gain from supplying details of their health for a bulk annuity. In the individual market, disclosing their health conditions may mean that their pension pot can buy a bigger annual income, in the bulk annuity market it simply affects the amount the scheme pays to secure the same benefit for the member.  However, this does not seem to have been a barrier in recent transactions.”

According to Towers Watson, while many trustees have been reluctant to ask their members for personal health information, expecting response rates to be low, this has not been the case. It shows that response rates have been high at over 70 per cent, with some schemes achieving 100 per cent response rates. It suggests this would have been achieved in part by the development of the standard medical questionnaire, which is quick and easy for most members to complete, and allows a competitive process to be run with multiple insurers.

Griffiths said: “We believe this market may currently offer a significant opportunity for schemes with liabilities of less than £50m or where a small number of individuals represent a high proportion of the liabilities. We also believe that the difference that medical underwriting can make to price means that some schemes will be a lot closer to settlement than they think.”