The year to date has already seen a new record for the largest longevity swap - the £5 billion transaction by the Aviva Staff Pension Fund, and the record for the largest bulk annuity broken by the two buy-ins, totalling £3.6bn, for the ICI Pension Fund. At the end of Q1, 2014 was already the third largest year to date in this market.
A trend started in 2013?
Last year was also a record-breaking year for the bulk annuity and longevity swap markets, with the £1.5 billion bulk annuity for the EMI Pension Fund and BAE’s £3.2 billion longevity swap.
A key reason for this was the strong performance in equity markets over the summer of 2013, combined with an increase in gilt yields, which led to significant improvements in solvency levels for many schemes, making transactions more affordable. Many trustees and sponsors found themselves further along their de-risking journey plans than perhaps they had anticipated and have looked to ‘lock in’ the gains made over the year with de-risking transactions.
We have also observed a change in the mindset of trustees and sponsors with regard to buy-in contracts: these are now being regarded as an asset class in their own right that can be used in schemes’ LDI structures. This has led large schemes where buy-out and wind-up isn’t necessarily a long-term objective to use bulk annuities as investments.
Supply and demand factors
On the demand side, only a minority of schemes currently hold annuities or longevity swaps as part of their investment portfolio. More will want to, particularly if funding levels improve, and many of those who have already browsed are getting ready to buy. Schemes are becoming increasingly sophisticated when it comes to monitoring market opportunities and are using this time to remove potential obstacles to a timely transaction.
Existing bulk annuity providers also appear to have considerable appetite to write transactions at the current time, perhaps driven by a more benign market environment. Further appetite may be generated following the recent Budget announcements, as existing, and potentially new, insurers look to concentrate on bulk annuities rather than the individual market.
Looking behind the transactions, 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 increasing number of players and the size of transaction reinsurers will consider growing as they become more confident with UK longevity risk.
Pension schemes looking to hedge longevity risk are also increasingly look for innovative ways of accessing the reinsurance capacity. The Aviva Staff Pension Scheme achieved this by transacting a longevity swap via an insurance subsidiary within the employer’s group. However, this approach has wider applicability than just pension schemes with life insurance sponsors – it is possible for pension schemes to create insurance entities specifically for this purpose.
Several features of the ICI transaction reflected its size, for example the transaction was split across two insurers to achieve their desired scale.
More to come?
We believe that transferring risk makes sense for more schemes, and at greater scale than has happened to date.
Many of the UK’s largest pension schemes have been watching the bulk annuity market and longevity swap markets develop in recent years. and as demonstrated by the record transactions so far, 2014 will be the year that many of these schemes choose to act.
Ian Aley is a director at Towers Watson