Pension plan derisking in U.K. reaches record level

December transactions push amount unloaded to 16 billion, which could be the new normal

Three U.K. companies have recently unloaded a combined 5.3 billion ($8.7 billion) in longevity risk from their pension funds, making 2013 a record-breaking year for such transactions.

The deals bring the total volume of pension risk transactions, which include longevity swaps and bulk annuity arrangements, in the U.K. to a record 16 billion for the year.

The previous record was 12 billion in 2011. Since 2008, the yearly average had been about 8 billion.

But experts think 2013's higher level of activity could become the norm.

In December, pharmaceutical company AstraZeneca UK Ltd. and construction services firm Carillion PLC entered into separate longevity swaps with Deutsche Bank AG.

Also, BAE Systems PLC announced it had agreed to longevity insurance deals covering 1.8 billion of liabilities across two of its pension funds with Legal & General Group PLC, confirmed a spokeswoman for the defense contractor.

AstraZeneca Pension Fund Trustee, Cheshire, England, entered into a 2.5 billion longevity swap.

Matt Wilmington, partner at Aon Hewitt, the lead adviser to the pension fund, said the deal covers about 40% of the total liabilities of the AstraZeneca fund, which has $6.9 billion in assets, and 10,000 of the fund's current retirees.

In a statement, Mr. Wilmington said: “It was clear during the negotiations for this transaction that the capacity and appetite of the global reinsurance market to take on pension fund longevity risk is ever increasing.

“Together with Deutsche Bank we ran a competitive process, including the established reinsurers as well as a number of new market entrants, which has enabled the fund to transact at the best available terms,” he said in the statement.

Alexandra Lynch, spokeswoman for the pension fund, could not be reached by press time.

Carillion PLC, Wolverhampton, England, entered into a longevity swap for its five defined benefit pension funds with Deutsche Bank valued around 1 billion.

The deal covers about 50% of the pension funds' liabilities, said Suthan Rajagopalan, principal and DB plan risk transfer expert at Mercer, which advised the plans' trustees.

The swap hedges against the risk of rising costs as a result of the current retirees in the pension funds living longer than expected. The deal was priced as a single plan but executed as five separate swap contracts to reduce costs but retain flexibility, according to a Mercer news release. It covers around 9,000 retirees.

PricewaterhouseCoopers International Ltd.'s pension team advised Carillion. A spokesman for Carillion could not be reached for further comment.

Longevity risk

The BAE deal, announced Dec. 19, covers the risk of 17,000 members of the Royal Ordnance Pension Scheme and Shipbuilding Industries Pension Scheme, both of Farnborough, England, living longer than expected. The pension funds have 1.3 billion and 1.5 billion of assets, respectively.

The BAE spokeswoman said these deals cover about 60% of the Royal Ordnance Pension Scheme's total liabilities and about 40% of the Shipbuilding Industries Pension Scheme's total liabilities.

“We seek to mitigate pension liability volatility where we can,” said Peter Lynas, group finance director, in a BAE Systems news release. “This arrangement provides us with a greater degree of certainty as to future pension scheme cash flows as we continue to make provisions for our pensioners. This is another proactive measure we have taken as part of our strategy to manage risk associated with our pension schemes.”

Legal & General has retained 15% of the longevity risk for the Royal Ordnance Pension Scheme. The remaining 85% has been reinsured with Hannover Re Group. It retains 30% longevity risk for the Shipbuilding Industries Pension Scheme with the remainder reinsured with Reinsurance Group of America Inc.

Aon Hewitt assisted BAE on the deal.

Experts think the trend will continue into next year as risk transfer deals move into the mainstream. They expect to see new types of deals involving small and midsize funds.

“In the U.K. it looked for a while that 12 billion of DB risk transfer in 2011 might have been a blip,” said Mercer's Mr. Rajagopalan. “I wouldn't be surprised if this 16 billion volume in 2013 is not a blip — I suspect it is going to continue at a similar level, if not slightly above, as there are a number of potentially large transactions in the market looking to progress along the decision-making process. Total transaction volume since 2008 is 59 billion — made up of 34 billion in bulk annuities and 25 billion of longevity swaps — and we are expecting that to soar through the 60 billion mark early next year.”

“It was a very strong year as corporates and trustees continue to focus on the most cost-effective risk management strategies at the same time as the supply of longevity risk-takers is ever-increasing with over 15 reinsurers now bidding on this type of risk,” said Aon Hewitt's Mr. Wilmington. “There is no reason to expect anything different in 2014.”

“We are expecting the market to continue to develop — on the supply side we expect more simplified longevity swaps,” added Mr. Rajagopalan. “At the moment the majority have been quite complex transactions with very large schemes involving security structures such as collateral. We are expecting more simplified, uncollateralized transactions, more akin to pensioner buy-ins. That is more accessible for small and medium schemes.”

This article originally appeared in the December 23, 2013 print issue as, "Plan derisking in U.K. reaches record level".