Lack of middleman could pave the way for cheaper deals

If once the longevity swap market could have been described as a sleeping giant, it is undoubtedly wide awake now.

The Aviva Staff pension scheme’s £5bn deal with reinsurers Munich Re, Swiss Re and Scor – half as big again as the second largest swap – has stretched the possibilities of the market at a stroke.

Longevity swaps give schemes protection against the risk of members living longer than expected. There has been growing demand from global reinsurance firms to take on pensions longevity risk as a way of counteracting existing life insurance risk.

Aviva’s transaction, which covers 19,000 pensioners and a third of the scheme’s longevity risk, is the latest in a recent surge in deals which totalled nearly £9bn in 2013, surpassing the amount of risk hedged by the bulk annuity market. It had previously been assumed the swap market was closed to small pension schemes because they lacked the scale and very large funds because of a lack of capacity.

Goldie Murray, trustee director at the National Grid pension scheme, told Pensions Insight how his scheme had abandoned the idea of a swap several years ago because its liabilities were too large. “We found that because of the size of our scheme, we would have been in aggregate more than the market put together… the market was too small to accommodate us”, he said.

The scheme was also able to complete the transaction without the use of an intermediary

Aviva’s deal will have gone some way to dispelling concerns over the market’s ability to write large deals. The pension scheme was also able to complete the transaction without the use of an intermediary, a development expected to become more common.

Crawford Taylor, scheme actuary and partner at Hymans Robertson, advised on the deal. He said the Aviva deal would “pave the way” for “more innovation around how schemes can transfer longevity risk rather than through the traditional method of going to insurers who then reinsure”.

As the market has become more transparent, the role of the middleman has become more obvious, as has the costs

Schemes and reinsurers use investment banks and insurance firms as middlemen. Sadie Hayes, senior consultant at Towers Watson, previously commented “as the market has become more transparent, the role of the middleman has become more obvious, as has the costs – the other parties to the longevity hedge are increasing questioning whether it is necessary to have a third party”.

But it’s important to remember the Aviva trustees had the advantage of having a sponsor which is itself an insurance company. Martin Bird, partner and head of risk settlement at Aon Hewitt, said “in some sense Aviva is a bit of a one off… it has a ready-made vehicle.

“The challenge is to translate that into the broader market, where sponsors are not insurance companies.”

According to Towers’ Hayes, alternatives to using middlemen include reinsurers using an insurance subsidiary or trustees or their sponsor setting up their own insurer.

The deal represents a bit of coup for Hymans Robertson. Aon was lead adviser on £8bn of the £8.9bn of longevity risk written last year and estimates capacity at £100bn over the next two years, so there’s plenty to fight for as more schemes consider a hedge.

Deal stats

Liabilities covered: £5bn, 19,000 members or a third of longevity risk

Reinsurers: Munich Re, Swiss Re, Scor

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