Longevity reinsurance is a business with potentially huge demand, potentially huge supply and a big problem handling the volume of business expected when the two come together. This year, Prudential Financial tried to address that problem by hardwiring the know-how of a small team of specialists into something resembling an underwriting machine.
The overhaul is a reaction to looming capacity constraints in the longevity risk space. The volume of reinsurance – used by pension schemes to partially de-risk and by insurers to pass on risk from pension buy-ins and buy-outs – has doubled in five years, and could double again in the next five, says Amy Kessler, head of longevity risk transfer at Prudential Financial.
A more systematised approach – using a new suite of models and analytical tools – should help Prudential keep up. Whereas last year the firm priced only a third of deals that came its way, the overhaul meant it was able to price nearly all activity in the first seven months of 2017.
“I used to have three rock star underwriters who embodied this knowledge base and ability. By creating the right models, training the right people and being thoughtful about the processes, we’ve gone from three rock star underwriters to 12 or 14 people who can do this with confidence,” Kessler says.
The question a reinsurer has to ask, put bluntly, is whether the current crop of pensioners – the in-force policies – will die more or less rapidly than their predecessors. Prior to Prudential’s revamp of the process, this was painstaking work, involving the comparison of huge datasets and the search for usable signals.
“We’d spend days mulling over how married [a group was] or over distinctions between the in-force and the experience data,” says Kessler.
The intricacies made it an exacting task. If a company had changed over time – perhaps through acquisition – mortality rates in the experience file could differ markedly from those in the group to be covered, for example.
Now, the underwriting for small schemes that fall within specific criteria is automated and near-instantaneous, Kessler says.
The small schemes bring us diversity: companies in all industries; people all over the UK; socio-economic diversity. Years from now, those myriad smaller schemes will give us a better, more robust blockAmy Kessler, Prudential Financial
The change comes at a helpful time. Pension de-risking has bounced back after the EU referendum in June 2016, when the UK’s quarter-point rate cut and sterling’s fall threatened to freeze activity in what is the biggest pension de-risking market.
Globally, public longevity reinsurance deals so far this year total more than $12 billion.
The increasing deal flow gives reinsurers a chance to build a more diverse book of business, to which end Prudential Financial has launched its first flow reinsurance programme.
The arrangement enables insurers to build books of liabilities from groups of small pension schemes with a view to reinsuring the longevity risk from those books with Prudential periodically. In theory, the insurer knows it has reinsurance capital lined up – and knows the cost – giving it greater confidence when pricing deals for end-clients. Prudential, in return, has a steady flow of smaller pension liabilities coming into its book, mitigating the idiosyncratic risks that can be hidden in lumpy pools of liabilities.
“The small schemes bring us diversity: companies in all industries; people all over the UK; socio-economic diversity,” Kessler says. “Years from now, those myriad smaller schemes will give us a better, more robust block.”
The bigger deals continue, of course. In late 2016, Prudential was awarded its first reinsurance of longevity risk from an insurer’s personal pension annuity back book, a process that allows an insurer to achieve capital relief under Solvency II.
BT was groundbreaking, but we think of the Marsh & McLennan deal as market-makingAmy Kessler, Prudential Financial
By reinsuring longevity risk in matching adjustment portfolios – covering an insurer’s liabilities in return for fixed cashflows – Prudential reduces risk margin capital charges on the liabilities for its client.
The Solvency II matching adjustment allows insurers to discount liabilities in line with asset yields if the cashflows of assets and liabilities match, but the regime’s risk margin penalises insurers for unhedgeable risks, including longevity risk.
This year has also seen Prudential complete the first big non-intermediated reinsurance deal since British Telecom’s (BT) breakthrough deal in 2014 – a transaction for Marsh & McLennan worth £3.4 billion in September.
Non-intermediated deals, which use a captive rather than a third-party insurance company to stand between the corporate and reinsurer, should appeal to bigger pension schemes – cutting costs at the expense of a little more complexity, Kessler explains.
The idea has taken a while to get going though, and only relatively small transactions had followed BT’s path before now. The Marsh & McLennan deal – the first chunky transaction to go through the market since BT – is the true proof of concept, she claims.
“BT was groundbreaking, but we think of the Marsh & McLennan deal as market-making,” she says. “It was important to have a deal in the captive space that just made sense. It wasn’t a ‘gazillion’ dollars and so large as to be a curiosity, but you look at the deal and think: I get it.”