Bulk annuity and longevity swap providers believe the Eurozone crisis has the potential to close off opportunities for pension schemes looking to transfer risk to third parties, but also to create new ones, according to a report from Towers Watson.
Providers interviewed by Towers Watson noted that:
Schemes with bigger deficits will usually have to retain some risks for longer. However, strong demand for liquid assets allows trustees holding gilts to sell them and buy annuities at lower cost.
There will be windows of opportunity as volatile market conditions cause providers’ prices and schemes’ asset values to move around. But there is also more danger that prices will change before a transaction is complete.
Providers could increase prices if they start expecting more defaults on the assets they hold to back annuity commitments.
Ben Stone, a senior consultant at Towers Watson, said: “The latest blow to scheme funding levels has made full buyout a more distant prospect for many schemes. However, this cloud has a silver lining: buying in annuity policies to cover existing pensioners can be more affordable for those who have seen the value of their gilts outpace the rise in annuity prices. Market turbulence will open doors then quickly slam them shut, so schemes need to work with providers to accelerate the completion of transactions and lock down the price in the run up to the trading day.”
Towers Watson’s review of the pension risk transfer market is published at a time when a bumper year has been followed by a relatively slow start to 2012. Bulk annuities and longevity swaps covering £12 billion of liabilities were signed during 2011. Towers Watson, which advised on 10 of such deals last year, ranging from a £5 million bulk annuity policy to a £1.7 billion longevity swap, points to several reasons why schemes looking to transact should prepare early.
Ben Stone said: “In 2011, there was something of an ‘end of year sale’ as providers cut prices to hit new business targets. Whether it is economic conditions or unfulfilled appetite from providers that makes pricing attractive in future, the schemes that benefit will be those who have cleaned their data and established effective decision-making structures. Sometimes, providers with limited capacity may have to choose which schemes to engage with, and it is those who are transaction-ready who will be taken seriously.”
Several leading providers – Aviva, Deutsche Bank, Lucida, MetLife, Pension Insurance Corporation, Rothesay Life and Swiss Re – contributed thoughts on the state of the risk transfer market and how it might develop. Providers’ top tips for pension schemes looking to transact include making sure that trustee and corporate objectives are aligned, appointing experienced advisers, and establishing clear triggers for action. Ben Stone said: “De-risking transfers have to be approached like M&A activity: make sure all parties have the finance in place to do the deal and remember this is a negotiation leading to completion, not an interesting discussion.”
Providers expected that the coming years would see increased use of solutions involving deferred premiums, partial risk transfers or guaranteed pricing. Ben Stone said: “Employers’ commitment to tackling their pension legacies often runs deeper than their pockets. Recognising this, providers are developing ‘buy now, pay later’ solutions that require less cash up front in order to bring more schemes to market.”
Recently, the very largest transactions, have hedged longevity risk only and Towers Watson thinks this is likely to continue. So far, smaller schemes have normally hedged longevity risk as part of a bulk annuity contract. Although hopeful that standardised contract terms will reduce implementation costs, providers were generally cautious about the prospects of longevity swaps becoming a mainstream solution for smaller schemes.
Ben Stone said: “The risk that the individuals with the big pensions will live to a ripe old age is more significant when there are fewer members to start with. Insuring a risk concentrated in a few people is likely to come at a high price.”
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