Longevity risk is that which a pension scheme or life insurance company is exposed to as a result of the greater-than-expected longevity of pensioners or policyholders.
How a longevity swap works
Pension schemes most commonly deal with longevity risk by seeking to transfer this risk using an insurance contract. The scheme will cap payments to its members at an agreed level based on assumed life expectancy and insure any costs above that level for a pre-agreed premium.
Guernsey has been at the forefront of the development of longevity risk transfer. Recent years has seen two ground-breaking longevity swap structures being established in Guernsey using captive insurance companies in place of insurance intermediaries, thereby cutting out intermediary fees and removing the need for price averaging.
The first of these saw the trustees of the BT Pension Scheme, Britain’s largest corporate pension fund, set up its own captive insurance company and then reinsure its longevity risk with a US-based life insurance company. In the biggest deal of its kind, the arrangement covered 25% of the scheme’s exposure to increased life expectancy and amounted to £16 billion of the scheme’s liabilities.
“The regulator and all of the companies in Guernsey recognise the business activity. They understand the risks and that is very helpful. From our particular experience we have met and now use a number of very experienced and talented people with both insurance and captive knowledge and they have been very adaptable and flexible in helping us to land what was quite an innovative transaction for the scheme - to actually create its own captive, certainly in a transaction of this size.” John Coles, Head of Operations for the BT Pension Scheme
The BT Pension Scheme deal was followed by the Towers Watson ‘Longevity Direct’ structure which enables pension schemes to gain direct access to the reinsurance market in order to hedge longevity risk. It was announced at the beginning of 2015 that the Merchant Navy Officers Pension Fund (MNOPF) has utilised a cell within Towers Watson Guernsey ICC to hedge £1.5 billion of its own longevity risk.