Insurers eye longevity swap market

The withdrawal of banks from the longevity swaps market is presenting opportunities for insurers to muscle in. But while pension schemes may be keen to offload longevity risk to the insurance market, pricing and risk analysis of the deals can be difficult. Thomas Whittaker reports

Insurers and reinsurers are making their presence felt in the longevity swap market. In January, Legal & General (L&G) undertook its first longevity swap transaction, confirming a £1 billion deal with Pilkington Superannuation Scheme. Later in the year, Swiss Re signed its first longevity swap deal for three years, with a £1.4 billion transaction with the pension scheme of Dutch chemicals group AkzoNobel.

Other insurers and reinsurers are also looking at opportunities to take on the longevity risk from pension schemes, as banks begin to pull back from the market.

David Prowse, senior director of life insurance at Fitch Ratings in London, says there is potentially huge scope for insurers to penetrate this sector: “Pension schemes are looking to offload a lot of longevity risk, and insurers, whether they are life insurers or reinsurers, have the capability to take that on. There is potentially a big market that could develop.”

UK corporate direct benefit pensions liabilities, all of which are exposed to longevity risk, are around £1.4 trillion, according to L&G. There is also more than £1 trillion of public sector pension liabilities.

Insurers such as L&G, Aviva and Prudential have for many years been taking on pension scheme liabilities through buy-ins and buy-outs. But longevity swaps – derivatives contracts that offset the risk of pension scheme members living longer than anticipated – are potentially more attractive for a number of reasons.

One advantage is that in the case of a longevity swap, there is less asset risk than there is in bulk annuity deals, as the insurer will have to hold fewer assets against the swap.

In a longevity swap, the pension scheme provides the counterparty with regular
payments based upon agreed mortality assumptions and, in return, the counterparty pays out an amount based on actual mortality rates.

The asset risk is of particular concern, given the uncertainty over the treatment of long-term guarantee products such as annuities by Solvency II, according to Charlie Finch, a London-based partner at consultancy Lane, Clark & Peacock (LCP).

“Over the past two years, we have seen continued uncertainty around Solvency II, particularly over the matching adjustment. This has created uncertainty as to the type and length of assets an insurer should hold. With a longevity swap, the asset element is relatively small. At the outset it will be at the money, so neither party will be posting many, if any, assets,” Finch says.

“The assets held against the swap will increase if longevity moves [increases] significantly, but that will not be known until much further in the future, so the asset risk represents a much smaller part of the pricing aspect,” says Finch.

This means that, in some ways, insurers can price longevity swaps with more certainty under Solvency II than a buy-in or buy-out.

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Insurers eye longevity swap market