* Record year takes longevity market issuance to 25.1 bln
* Final salary pension schemes drive growing market
* Record 3.2 bln stg deal for BAE Systems
* AstraZeneca, Carillion, Bentley also come to market
By Simon Jessop and Jemima Kelly
LONDON, Dec 30 The market that final salary
pension funds are banking on to insure against the cost of
longer lifespans has chalked up a record 8.9 billion pounds
($14.7 billion) in deals in 2013.
Five years after its launch, reinsurers are hoping London's
"longevity swap" market will attract global business as
companies struggle to provide the fixed incomes they promised to
pensioners who are living longer than expected.
The industry believes the longevity market could be worth
$15-$25 trillion - and reinsurers see an opportunity in the
nascent market. Taking on some of the risk of pensioners living
longer than expected is one way to offset the early death risk
they all take on through the writing of life insurance.
The market set its record for risks hived off by schemes
this year with its biggest deal to date, of 3.2 billion pounds
from BAE Systems, along with others from AstraZeneca
, Bentley and Carillion.
Life expectancy has been consistently underestimated by
statisticians. To avoid the risk of being forced to pay out
money for longer than expected, many schemes are seeking to farm
out longevity risk.
The complex deals can take years to come to fruition.
But Andrew Ward, who advises pension scheme trustees for
consultants Mercer, said: "There's now a greater degree of
standardisation ... Everyone's confident you can do these
transactions and they're an accepted way of managing risk."
Many deals have come from larger pension schemes, but Martin
Bird, head of risk settlement at consultants Aon Hewitt, said
the relatively small Bentley deal, at 400 million pounds, showed
"the basic template is now in place".
In the swap, the pension scheme agrees to pay an insurance
company or a bank a fixed premium in return for them paying out
if pensioners live longer than expected. They then pass on all
or part of the exposure to the reinsurance market.
"It's attractive to a company to, in effect, draw a line
under how long their liabilities go on increasing," said John
Denning, Carillion director of group corporate affairs. "We
would have had no control over it otherwise," he added.
All such swaps so far have involved British pension
providers, many of which have defined benefit, or final salary,
schemes that come with generous inflation-linked payouts.
The headache those schemes inflict - and the 1 trillion
pounds worth of liabilities they represent - meant that British
providers were quicker to address the issue of people living
longer, said Bird.
While those early deals were run almost entirely out of
London, the centre for much of the global insurance industry,
discussions were now taking place with pension providers in
countries such as the Netherlands and Switzerland, said Bird,
who expects the first deals outside the UK next year.
NEED TO ACT
This year's transactions bumped the market's value over the
past five years to over 25 billion pounds, and Mercer's Ward
expects that to grow in 2014.
The pressure on pension providers to act is strong. The
International Monetary Fund estimates that for each extra year
of life expectancy, current liabilities in a typical defined
benefit pension scheme increase by 3 to 4 percent.
That means risk-holders are on the hook for an extra $450
billion to $1 trillion for every year they underestimate
longevity, a December study from the Basel Committee on Banking
Longevity swaps, which separate longevity risk from the rest
of the pension scheme's liabilities, are one way of managing
risk, but there are alternatives.
Under a "buy-out", the scheme transfers all its assets and
liabilities to an insurer in return for an upfront premium. At
that point the scheme has shed its liability to the pensioners,
who each receive their annuity payouts direct from the insurer.
In a "buy-in" deal, the pension scheme pays the premium in
return for regular annuity payments from the insurer, which it
then uses to pay the pensioners itself.
Though there are concerns about a longevity swap demand
ceiling in the reinsurance market that is estimated at between
50 billion and 200 billion pounds, that is some distance away.
When it comes, some say the only option will be to encourage
a broader range of investors, such as hedge funds or sovereign
wealth funds, who may see the market as a chance to diversify
because of its lack of correlation with other asset classes.
"One of the things we're trying to do is to attract
risk-takers, or long-term risk-holders, into the market as well
as insurers and reinsurers," said Andrew Reid, European head of
pensions origination at Deutsche Bank.