Tire Maker Strikes £600M Double Longevity Swap

Zurich Assurance has struck two longevity swap deals with tyre manufacturer Pirelli worth £600 million ($789 million).

The deals are “streamlined” longevity hedges, protecting two UK-based pensions run by Pirelli against the risk of 5,000 named members living longer than expected. Pacific Life Re provided the reinsurance facility.

Mercer, the lead advisor on the transactions, has a standardized contract agreed with Zurich for such transactions, speeding up the process for smaller deals.

“Often you have 100 pages or more in these contracts, so there is often a lot of debate,” said Andrew Ward, head of longevity risk management at Mercer. “There can be value in getting bespoke terms for larger transactions. We’ve tried to get the best terms from those larger deals upfront.”

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The transaction is the second Mercer has conducted through the standardized contract arrangement, the first being a £90 million deal struck roughly six months ago. No further details of this have been made public.

Earlier this month ScottishPower completed a deal worth $1.3 billion, its second multi-billion longevity swap in the past two years. Other well-publicized swaps include a $3.7 billion transaction for Heineken’s UK pension 12 months ago and a $2 billion arrangement for the Merchant Navy Officers’ Pension Fund in January 2015. The largest to date remains the BT Pension Scheme’s $21 billion transaction, completed in July 2014.

Ward said longevity swaps were previously accessible “for only the largest schemes, but this deal illustrates that competitive longevity reinsurance pricing is now achievable for small and medium sized schemes.”

Longevity could be a bigger risk to smaller pensions, Ward said, as they are “more exposed to concentration risk resulting from a greater variability in members’ life expectancy due to diverse pension amounts in smaller populations.” He said there were further small longevity transactions currently being planned, “including one of around £50 million of pensioner liability.”

As well as reducing the complexity of negotiations with insurers and reinsurers, the standardized terms also strip out the need to collateralize the swap, as is common practice with large deals.

“Significant steps have already been taken to manage other risks in the funds,” said Tony Goddard, pension manager at Pirelli. “We are pleased to continue this process with these transactions and to seize the early opportunity to hedge longevity risk. The longevity swaps help to improve the security of benefits for all members by removing the uncertainty from members living longer than forecast. They also allow us to retain future investment flexibility.”

The Research Affiliates Challenge: Two anonymous investment strategies compared side-by-side over a 53-year time span. One delivered annualized excess returns of 2.9% at an annualized risk of 16.3%. The other, 1.8% excess returns and 4.3% risk.

Another difference? The first—a buy-and-hold investment in the S&P 500—represented 60% of the average plan’s stock and bond holdings. The second—a value investing approach—made up just 20%.

“Owners of capital should be demanding an overwhelming value bias in their portfolios.”“Value investing is increasingly overlooked as a meaningful contributor in portfolio construction,” wrote Research Affiliates’ John West and Amie Ko. “For many investors, [it] is actually viewed as a risk to be diversified away.”

In a report published this month, the pair tackled the question of why value investing has fallen out of favor in institutional portfolios—while a bias toward equity remains “conventional wisdom in its ability to generate a reliable source of excess return.”

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In comparing the two strategies, West and Ko found that the value strategy had a higher win rate over rolling 15- and 3-year periods, as well as smaller excess losses in worst-case return scenarios.

“There seems to be a disconnect,” they wrote. “Owners of capital should be demanding an overwhelming value bias in their portfolios.”

The duo suggested that the current disdain for value is the result of cognitive bias. Soaring stock prices between 1970 and 2015, for example, has led to equities being viewed positively by today’s investors, resulting in a widespread belief in “stocks for the long run.” Value investing, meanwhile, has been “far less buoyant, and the range of outcomes much more modest” over the same 45-year period—causing investors to associate the strategy with less than stellar performance.

But equity outperformance “loses much of its punch” when rising valuations are taken into account, West and Ko argued. Annualized excess returns dropped from 2.8% to 0.8% on a rolling 15-year basis, while the corresponding win rate fell from 82% to just 43%.

The performance of value investments, meanwhile, slightly improved after adjusting for valuation changes—suggesting “the presence of historical structural alpha, not at all reliant on becoming more expensive,” the authors wrote.

“We should acknowledge that cognitive biases may surreptitiously influence our investment decision making,” West and Ko concluded. “We owe it ourselves to question why all long-term sources of excess return are not treated equally in our portfolios.”