Aviva longevity swap raises questions for intermediaries

Insurer goes direct to reinsurers for £5 billion pension scheme risk transfer


Bankers have welcomed a recent longevity swap from Aviva despite the deal being executed without intermediaries, a development that would appear to limit the future role of banks in the longevity market.

In a transaction announced in early March, the UK-based insurer transferred longevity risk relating to around £5 billion of pension liabilities to Aviva UK Life and then directly to three reinsurers (Scor Global Life, Munich Re and Swiss Re) rather than go through a bank intermediary.

The transaction, which has been flagged by advisers as the first where a pension scheme deals directly with reinsurers, is seen by some as the model for further deals because of the cost savings to be made. UK regulations prevent non-financial institutions from transacting directly with reinsurers.

Speaking about the Aviva deal, Crawford Taylor, a partner at UK-based consultancy Hymans Robertson, which advised the trustees, says: "This approach enabled the trustees to negotiate directly with the reinsurance market. If you can remove the fee of the intermediary, deals like this become a lot more attractive for pension schemes."

The same approach would be possible for other insurance companies seeking to transfer risk from their own pension schemes, and could be employed using a captive insurer, says Taylor. In theory a similar structure, but using a captive, could be applied to a corporate pension scheme.

Yet bankers have welcomed the deal as an indication of the growing maturity of the market and are playing down the idea that it might curb their own prospects and the involvement of capital markets investors in the longevity risk market.

Market participants at other insurance companies support this view, pointing out that insurers commonly reinsure longevity risk directly on smaller private deals. Aviva's transaction stands out mainly for its size, they say, and for the participation of three reinsurers working together.

Jeff Mulholland, head of insurance and pension solutions in the Americas and founder of the global longevity business at Societe Generale based in the US, says the future role of banks will be to help insurers and reinsurers, rather than to work with pension schemes directly.

"We can help to reduce the economic capital insurers and reinsurers must hold relative to the longevity risk they assume through transactions to hedge pension plans' exposure to longevity," he says.

Transactions in which a scheme is indemnified for the difference between actual and expected longevity for a long period (up to 60 years) make sense in cases where corporates want to transfer the economic impact of liabilities over a long period based on the longevity of a pension plan's actual participants, he explains.

The Aviva deal covers scheme members until death and covers the longevity of their specific pensioners as opposed to the longevity of a population index, which would be the basis for a tailored hedge.

Specific indemnity risks of this type are ill suited to a capital markets transaction where investors lack the expertise required to assess and underwrite the risk of the pool of pensioners. Investors also prefer investments that are shorter dated than the cover that schemes require.

Mulholland draws a parallel with the development of the catastrophe bond market in the early 1990s. Then reinsurers provided indemnity reinsurance to their primary property and casualty insurance clients and managed their risk through the purchase of hedges from capital markets investors in the form of catastrophe bonds and catastrophe derivatives based on indexes.

Reinsurers are left with a book of basis risk, he says – the risk of a mismatch between the indemnity risk they assume from their clients and the protection provided by the index hedges. Some reinsurers earned as high as 40% annual return on capital over a 10-year period with this strategy of managing a book of basis risk, says Mulholland, citing RenaissanceRe and Mid Ocean Reinsurance as examples.

"The analogy is direct," he says. "There is the opportunity for the reinsurers to be the experts on the indemnity risk, with the capital markets serving as a larger pool of capital for diversifying the more commoditised risk of the general population mortality improvement trend in a given country."

Rupen Shah, London-based head of longevity at reinsurer Scor Global Life and a participant in the Aviva deal, agrees in principle that insurers and reinsurers might transfer more risk to the capital markets in future, given the right conditions and tenure of cover available. He adds, though, that it might take time for such an approach to become standard.

The willingness of reinsurers to hold longevity risk on their balance sheet as a natural hedge for their mortality risk could slow the development of a wider market. One reinsurer says there is capacity for several years of investment at current rates.

Aviva's deal would help the banks if it prompts more activity from corporate schemes and thus places greater demand on that capacity.

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