Strategic Finance
Pension longevity swaps getting closer |
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| Strategic Finance | |
| Written by Editor | |
| Monday, 06 April 2009 | |
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It is odds-on that the coming months will see the first UK pension schemes buy protection against their members living longer while keeping control of how their assets are invested, according to Watson Wyatt.
Already a number of life insurers have transferred longevity risk either to a reinsurer or to investors via the capital markets. No transaction taking mortality risk directly off the hands of an occupational pension scheme other than through annuity contracts is yet in the public domain. However, Watson Wyatt is advising a number of companies and trustees on how they can best hedge their mortality risk. Providers of mortality swaps and insurance contracts also report having issued quotes to more pension schemes in recent months and say they have a strong pipeline of potential deals. John Ball says: “Longevity swaps allow pension schemes to protect themselves against unanticipated improvements in life expectancy so that members can live long and the company underwriting their pensions can still prosper. Until recently, the market price anticipated much higher life expectancy than schemes were allowing for in their funding reserves. That made swaps look like an insurance policy with a high excess charge. But the gap has narrowed as pension schemes are starting to set more cautious assumptions and greater competition is developing among the providers, so cost will be less of an obstacle for many pension funds.” In the long term, swap prices are as unpredictable as longevity itself but current prices could reflect competitive pressure. John Ball says: “We saw with pension buyouts that providers are very keen to plant their flags in the ground when a market appears to have significant growth potential. The same forces are at work here, so the pension schemes which move early may get the best deals.” The onset of the financial crisis worked against mortality-only solutions but the way it has developed could now favour them. John Ball says: “The early days of the credit crunch caused a spike in corporate bond yields. This persuaded insurers that they could make more money off their investments so bulk annuity prices fell. Pension schemes were not going to look seriously at hedging only their mortality risk when they could afford to go the whole hog and get protection against other risks, with the perception that mortality was almost thrown in for free. Now, though, while we still expect to see some bulk annuity deals in 2009, it has become harder to complete a transaction at a sufficiently competitive price.” Stock market falls have left most defined benefit schemes with substantial deficits, while few employers are able to inject the cash needed to transfer all pension risks to an insurer. Longevity swaps need not require upfront payments and may appeal to cash-constrained employers looking to hedge some of their risk as a first step on a long journey towards settling their pension liabilities. John Ball says: “Schemes which had not moved out of equities before the markets fell are still targeting settlement but expect it will take them longer to reach the finishing line. This increases the risk that changed longevity expectations will make annuities more expensive by the time they are ready to buy. That could make longevity hedging an attractive solution but there are a number of practical issues to consider. For example, the trustees and employer need to agree how any gap between the technical provisions and the fixed leg of the swap is to be funded. The long-term nature of a mortality swap contract also makes it essential that payments due from the counterparty are secured as new evidence affecting life expectancy emerges.”
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