Longevity Swap Market Still Constrained, Despite Growing Number of Deals

Pilkington Superannuation Scheme, the pension plan linked to British glass manufacturer Pilkington, has announced it has entered into a deal with insurer Legal & General (L&G) to swap out £1 billion of its longevity risk.

This is the first longevity swap carried out by L&G, which has been one of the major players in the pension buyout sector. L&G will insure only the longevity for those Pilkington scheme members already drawing their pension.

L&G said, in an announcement to the London Stock Exchange, that German reinsurer Hannover Re would take on the longevity risk assumed from Pilkington.

Ulrich Wallin, Chief Executive Officer at Hannover Re, said: “Going forward, too, we anticipate good business opportunities since it is likely that companies will increasingly seek to limit their direct pension obligations.”

A statement from the reinsurer said: “For Hannover Re the assumption of longevity risks also forms an attractive part of its risk management since longevity risks are negatively correlated with mortality risks and hence promote better diversification of the portfolio.”

This means that reinsurers can offset the mortality risk on their books by taking on longevity risk – it means that the capital they have to set aside for a longevity trade is often lower.

However, some in the industry fear there is not enough capacity in the insurance market to absorb all the potential risks that pension schemes may want to pay to manage.

Investment banks have taken centre stage in this industry due to their more immediate access to insurers and open markets. Few banks would take on and hold the longevity risk themselves, preferring to offload this to an insurer or reinsurer.

Last year, Deutsche Bank, an active participant in the sector, said the appetite by the reinsurance market was around £20 billion per annum

In 2011, just over £6billion in longevity risk was absorbed by the reinsurance industry as there remains no real market trading this risk amongst other participants.

Martin Bird, Head of Risk Settlement at Aon Hewitt, which advised on the Pilkington deal, said: “At the moment we have around £15 billion of capacity per year from reinsurers – and despite the increasing number of deals we are not likely to exceed that this year or probably next.

“There are new reinsurers coming to market, but realistically we are not going to run out of capacity in the near future with the 10-12 that are currently seriously active.”

Today’s announcement follows a series of deals in the past two years, including multi-billion pound longevity swaps by car maker BMW, airline British Airways and television company ITV. The largest deal to date was the £3 billion transaction by the pension scheme attached to engine and car maker Rolls Royce, last year.

These deals have been transacted by investment banks: Deutsche Bank, Credit Suisse and Goldman Sachs. Last year Swiss bank UBS joined forces with UK consultants and actuaries Barnett Waddingham, to accumulate more accurate information for potential longevity transactions.

Bird said that the market for trading longevity risk had not taken off quickly when it began in the 1990s, but as more deals were taking place a new standardised format and of a greater size, this would force a market to develop more rapidly.

He said: “Fund managers, sovereign wealth funds and a host of other diversified investors find this asset class attractive – the only mismatch might be that their investments are likely to be of a shorter duration than the original deal by the pension scheme.

“However, this mismatch should spur the investment banks on to find a solution to create a functioning capital market,” Bird said.