Ian Aley, head of transactions at Towers Watson, said:
“We are noticing a big increase in the number of pension funds who want to de-risk their liabilities in the next 12 months. The practice has become more established over the last few years and with strong demand from insurers and reinsurers, prices are attractive, making it a good time to secure a deal.
“Last year we saw a record £35bn of liabilities hedged as well as the largest ever single transactions for both longevity swaps and bulk annuities. This pushed the total value of deals up to a level we do not anticipate seeing this year. Instead 2015 is likely to be characterised by an increase in small and medium-sized deals taking place as innovative new structures emerge providing easier and more cost-effective access to the longevity hedging and bulk annuity markets.”
Affordability
In the longevity hedging space, 2014 saw the MNOPF, BT Pension Scheme and the Aviva Staff Pension Scheme access the reinsurance market more directly, via insurance companies either already owned by the sponsor or set up to facilitate the transaction, such as through Towers Watson’s Longevity Direct. This is a trend Towers Watson believes will continue in 2015, and should lead to more activity in the longevity hedging market.
“Accessing the reinsurance market more directly means significant savings in terms of the cost of hedging longevity and also reduces the complexity involved with these transactions. It provides another option for pension schemes keen to choose a cost effective way to hedge longevity,” said Aley. “On the bulk annuity side, combining buyouts with Pension Increase Exchange (PIE) exercises and winding up lump sums, can improve affordability. Longer term, if more members take transfers out at retirement, this should also improve affordability for schemes.
“The concept of ‘top slicing’, where a medically underwritten bulk annuity is transacted for those members with the highest liability, is a useful option for schemes with concentrations of longevity risk.”
Supply, demand and pricing
The report notes that the current demand for UK longevity risk from reinsurers means that there is significant competition. This in turn is likely to encourage more pension schemes to explore bulk annuity or longevity hedging options in the short term. But the report also warns that in the longer term the supply and demand balance is likely to even out and the reinsurers may increase their pricing..
Ian Aley said, “The current demand for UK longevity risk from reinsurers is driven by a desire to offset their existing mortality risk due to diversification benefits, so prices have been favourable for pension schemes looking to enter into longevity swaps. But we anticipate that £50-100bn of supply from reinsurers could easily be filled by pension schemes in the near future, which is likely to put upward pressure on prices in the longer term.
“On the bulk annuity side, if pricing improves over the first half of 2015, or there is a rise in equity markets, we could see unprecedented demand from pension schemes and insurers may have to pick and choose where they can quote.”
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