British Airways Offloads £1.3 Billion of Longevity Risk

(December 20, 2011) — British Airways has announced a £1.3 billion longevity trade, taking its hedge on increasing life expectancy to 40% of pensions in payment — a reflection of the burgeoning activity in pension risk transfers.

The firm’s Airways Pension Scheme (APS) entered into the buy-in deal with Rothesay Life to insure against scheme members’ increasing benefits. Towers Watson advised APS on the longevity strategy. The deal marks the second time Rothesday has insured APS longevity risk, as it provided a further £1.3 billion insurance in June 2010 for 20% of APS’ pensions in payment.

Paul Spencer, Chairman of the Trustees of the Airways Pension Scheme, commented; “One of our principal objectives is to make members’ pensions more secure. Most of our investments aim to produce an income that closely matches the pensions we expect to pay, but this still leaves the risk that longevity could improve faster than we have budgeted for. We identified an opportunity to further protect the Scheme against some of these extra costs and, after thoroughly reviewing options with our advisers, selected Rothesay Life again based on their ability to structure a contract around our needs.”

Keith Satchell, Chairman of Rothesay Life, added: “We are very pleased that we have been able to work with the Trustees again to insure additional benefits against increasing life expectancy. We believe this extension further demonstrates Rothesay Life’s expertise in designing and executing solutions. This is the second repeat trade for Rothesay this year, which we believe is a real endorsement of the team.”

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Further evidence of the reflection in the uptick in activity in pension risk transfers, primarily in the United Kingdom, comes from Prudential’s longevity reinsurance transaction with Deutsche bank, conducted earlier this month.

The buy-in/buy-out market is still substantially more developed in the UK compared to its US counterpart, magnified by regulatory and accounting reform, consultants and others in the industry told aiCIO. In terms of deals, de-risking volume is roughly five times greater in the UK compared to the US, and in terms of longevity-only transactions, there have been 10 such deals completed in the UK, with none in the US, according to Amy Kessler, senior vice president and head of Prudential’s Longevity Reinsurance business. The number of such pension risk transfer deals in the UK market has been growing in recent years as pensions seek to transfer their risk to banks and insurers.

Pension consultancy Hymans Robertson showed in a May study that with $7.2 billion (£4.5 billion) of risk transfer deals completed last year, the second quarter of 2011 looks to be a record quarter for the number of buyin and buyout deals completed in the UK. James Mullins at Hymans stated in a release that by the end of 2012, one in four FTSE 100 companies would have completed either a buyout or a buy-in.

A newly released report -- furthering the debate between active and passive management -- concludes that while finding superior active managers is not easy or simple, it can be done.

(December 20, 2011) — A new academic paper providing further fuel to the active versus passive management debate asserts that investors who can identify superior active managers (SAM) should be able to improve their overall Sharpe ratio by including a meaningful exposure to active strategies.

“Most debates have a clear winner: Lincoln beat Douglas, Kennedy beat Nixon, and Reagan beat Mondale. But the debate surrounding active versus passive management continues to rage after more than 40 years of contention,” asserts Robert Jones of Arwen Advisors and Russ Wermers of University of Maryland’s Robert H. Smith School of Business in their paper titled “Active Management in Mostly Efficient Markets.”

In response to why active management is here to stay even though, according to many academic studies, the average active manager doesn’t add value, Jones told aiCIO: “Its the combined activity of all these active managers that keep markets efficient and thereby hard to beat, and efficient markets mean better capital allocation, and thus greater growth and wealth for society as a whole. To reap this huge benefit, markets must encourage active management, which they do by heaping huge rewards on SAMs. Our paper also highlights that it may be possible for fund investors to identify SAMs in advance based on various metrics and characteristics.”

According to the authors, the research paper aims to answer the following three questions:

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1. Does active management add value?

2. Can we identify superior active managers ex ante?

3. How much active risk should investors include in their portfolios?

The paper concludes: “If we assume that the aggregate of all actively managed funds is equal to the market—that is, active management is a zero-sum game—then the aggregate of active fund returns equals the market return but incurs trading costs and charges fees, and so the aggregate will underperform the market by an amount equal to fees and expenses. Empirical studies seem to broadly support this conclusion…Active management will always have a place in ‘mostly efficient’ markets. Hence, investors who can identify SAMs should always expect to earn a relative return advantage. Further, this alpha can have a substantial impact on returns with only a modest impact on total portfolio risk. Finding such managers is not easy or simple—it requires going well beyond assessing past returns—but academic studies indicate that it can be done.”

The report jibes with recent remarks by Sam Kunz, head of the Chicago Policeman’s Annuity and Benefit Plan, who spoke with aiCIO earlier this year about international pension differences, mushroom hunting, and overconfidence. “In Switzerland, mushroom hunting is very popular. In the fall, there is a high probability there will be mushrooms when the sun is shining just after rain. But perfect conditions don’t guarantee you will be successful in finding any. The same holds true for active management,” he said. “At any given point of time, there are inefficiencies somewhere available to someone, but it doesn’t mean that investors are able to capitalize on them. In other words, markets might not be efficient, but the trick is to be able to take advantage of that inefficiency despite its versatility. Therefore, the budget for active management should be spent very wisely because our ability to consistently capture these opportunities is low.”

Giving light to the opposite side of the debate, research released earlier this year — carried out by students at Uppsala University — showed that if the stock market is on the upswing, then a passive management approach across a broader market index may be superior to an active approach. The study revealed that during periods when the stock market was on an upswing, actively-managed funds faced difficulty outperforming the index. However, during falling stock markets, actively-managed funds were more likely to outperform the index.

Undoubtedly, the active versus passive debate has been a popular topic within the institutional investor world. Mirroring the Stolkholm-based study, Lee Partridge, San Diego County Employees Retirement Association’s (SDCERA) outsourced portfolio strategist and CIO at Salient Partners, offered a skeptical tone. “We think that it’s important to get all the different strategies represented in a well-diversified portfolio…but are you really trying to bring in the return premium that comes from those strategies, or do you think the manager has skill over and above the strategy?,” he told aiCIO. “We think that both can be operable, but we’re fairly skeptical about skill. We think that skill really has to be proven and it’s very difficult to detect.”