The pension scheme de-risking market: how to find value

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Ian Aley, head of transactions at global advisory, broking and solutions company Willis Towers Watson, shares his views on the relative attractiveness of the current bulk annuity and longevity hedging markets

The dynamics of the pension de-risking market may be summarised as market conditions mixed with supply-and-demand forces, with an overlay of regulation.

This melting pot leads to a cyclical market with different structures, offering more value for money than others at a particular time. Since I started working in this market as an insurer about 20 years ago, I’ve observed many such cycles, and now as a de-risking adviser to pension schemes I help my clients seek the best available opportunities.

The longevity hedging market in late 2015-16 is a good example. More than £20bn of longevity risk associated with back books (insurers’ historic bulk and individual annuities) was passed to reinsurers over the period.

This activity kept reinsurers very busy, diverting their attention from pension schemes. Furthermore, the insurers were a somewhat forced seller of the risk, driven by changes to their regulation.

For this reason, we advised our clients seeking to hedge longevity risk to wait for this back-book bulge to subside before hedging. This back-book longevity hedging activity has now reduced and we believe longevity hedging fees have become more attractive.

However, the fee is not the only element of the cost of longevity hedging. A question currently attracting significant debate is whether now is a good time to lock into reinsurer longevity assumptions in the light of two years of heavier than expected deaths.

Willis Towers Watson research shows that reinsurers have reflected the heavier deaths experience within their pricing assumptions. The like-for-like pricing we have obtained has reduced over the past two years, and significantly in the case of some reinsurers.

So my advice to schemes is that now is arguably a good time to hedge, as the fee levels have reverted after the back-book rush, while the underlying assumptions have been relaxed since the heavy mortality observed in 2015 and 2016.

The bulk annuity market has also been interesting from a supply-and-demand perspective over recent years. Price attractiveness in this market has driven the yield achieved above risk-free through the insurer investing in credit.

For the past 10 years we have been receiving a live feed of pricing from insurers, analysis of this data reveals that the relative value available for pension schemes reduced in general over 2014-15, returning to more attractive levels late last year.

The pricing observed recently remains compelling for many pension schemes. Looking forwards, however, there remains a big caveat regarding back books. To the extent that an insurer puts its back book up for sale, this has the potential to distract the bulk annuity providers from pension scheme deals – as was the case in early 2016 as Aegon transferred its £9bn back book.

This activity can result in providers targeting their pricing resources and high-yielding assets on trying to win the back-book transaction. Back books may be attractive to the providers, as they already hold “insurer-friendly” assets so larger transactions are achievable, while the sellers are motivated to release reserves.

My advice to schemes, particularly those looking to complete larger transactions, is to be aware of the back-book market when considering the timing of their approach to the market. On a positive note, insurers are likely to offer more attractive pricing if they have been left disappointed after missing out on back books.

There will always be cases where completing a transaction makes sense despite the market dynamics. For example, many larger clients of Willis Towers Watson need to phase in their longevity hedging over time as their liabilities are too big to transact at once.

For these schemes, starting now with an initial proof-of-concept trade, which locks into the known reinsurance capacity, makes sense. Similarly, we have clients who have taken advantage of particularly attractive pockets of opportunity in the buy-in market.

Many schemes have taken significant de-risking actions on the investment side, meaning longevity risk becomes the dominant risk. Here removing longevity risk, either through a buy-in or a longevity hedge, makes sense from a risk-return perspective.

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