Mega deals and new products for small schemes keep pushing the limits of the market

Time was, longevity swaps were the equivalent of the Olympic Games in the world of pension risk transfers.

They came along infrequently, spectacularly grabbing the headlines as blue chip firms such as BAE, Rolls Royce and British Airways signed multi-billion pound contracts.

The BT pension scheme’s £16bn swap with the Prudential Insurance Company of America, the largest to date, covers three times the liabilities of previous record-holder Aviva’s £5bn deal set in March this year. Both swaps used specially created insurance companies, cutting out the middlemen, allowing schemes and their sponsors to deal directly with the re-insurers whose appetite for pensions risk is driving the market.

Aviva pioneered this kind of ‘captive’ insurance for pensions, leaving some to believe the deals would be restricted to those schemes with sponsors in the insurance or financial services sectors. But BT’s successful use of the model will have pricked the ears of UK Plc.

The scheme was able to approach a range of reinsurers directly

Ian Aley, a senior consultant at Towers Watson, advised the BT scheme trustees. “By setting up a wholly owned insurance company, the scheme was able to approach a range of reinsurers directly”, he explained. 

“Usually, a pension scheme will pass longevity risk to an insurer or a bank, which will then reinsure it. That means paying a cut to an intermediary, which will have its own requirements for the transaction.”

Aley does not expect many schemes to adopt this approach but said the consultancy is developing “other solutions to help our clients access the reinsurance market efficiently.”

Towers Watson’s great rival Mercer may have already stolen a march. Teaming up with insurer Zurich, it has launched a longevity hedge product aimed at the opposite end of the market – starting at schemes with just £50m of liabilities.

Simon Foster – head of corporate life and pensions, UK and international savings at Zurich – told PI the reasons behind the launch.

You’ve got all the competitive dynamics but you’ve got that within a pre-agreed commercial framework

“Traditionally the market has been at the billion pound mark and each deal has been painfully constructed with a wider market. Each writer would crawl all over the data, coming at in from different perspectives, and then there are the legal negotiations which are quite laborious”, he said.

Instead Zurich and Mercer have created a “much simpler, template approach… you’ve got all the competitive dynamics but you’ve got that within a pre-agreed commercial framework”.

Foster does not think his proposition has any crossover with the methods used by Aviva or BT – “you get that sort of structure at the large end, we’re aiming at the small end”.

He thinks there are about 1,000 mid-sized schemes currently cut out of the market who are potential clients. But Foster has modest goals: “If we’re standing here in three years’ time having done a dozen or so deals, we’ll think we’ve added to the range of options in the market place – that would represent a good result”.

Swaps are still seen as the icing on the de-risking cake

It is reasonable to expect the number of deals to remain low, especially when compared to the rampant bulk annuity market. Swaps are still seen as the icing on the de-risking cake as schemes battle with other, more pressing risks.

Foster concedes “matching assets and liabilities is pretty much first up” but notes that longevity hedges are “contracts of difference” where premiums are much smaller than in buy-ins and buyouts and spread over 25 to 30 years.

That will be music to the ears of pension managers and trustee boards of mid-market schemes for whom bulk annuity deals are still far off on the horizon.