What is a Longevity Swap?

Issue 2: July 2023

What is a Longevity Swap?

When it comes to pension risk transfer deals, buy-ins and buy-outs seem to grab all the headlines. However, longevity swaps are often much bigger, and many involve transatlantic agreements between UK insurers and U.S. reinsurers.

The UK insurer, Zurich, carried out two such transactions in June and May of this year: a £1.7 billion longevity swap covering c7,000 members of the Nationwide Pension Fund, and a £1.6 billion longevity swap covering c9,000 members of the Yorkshire and Clydesdale Bank (YCB) Pension Scheme with the U.S. reinsurers, Prudential Financial inc. and Pacific Life Re, respectively.

Commenting on the Nationwide Pension Fund deal in June 2023, Greg Wenzerul, Head of Longevity Risk Transfer for Zurich UK, said: “This solution represents a simple approach for pension fund trustees to manage their exposure to longevity risk. In a rapidly changing pensions de-risking market, longevity swaps continue to represent a sophisticated and valuable de-risking approach.”

Reinsurers view longevity risk as a natural hedge to their own mortality risk (i.e. the risk of policyholders dying earlier than expected). Therefore, most longevity swaps involve the risk being passed from a pension scheme to a reinsurer.

However, as reinsurers can only transact with insurers, pension schemes wanting to transact with a reinsurer, must do so via an insurer or via a captive insurer (i.e. an insurance company set up by the pension scheme to act as the intermediary).

Under the terms of a longevity swap contract, the scheme makes a series of ‘fixed’ cashflows to the reinsurer, representing the best-estimate projections of the pensions payable to the insured population.

In return, the scheme receives ‘floating’ cashflows from the reinsurer equal to the actual pensions due to the insured population. The pension scheme is therefore no longer exposed to the risk of the insured population living longer than expected.

Longevity risk is the risk of pensioners living longer than the actuarial assumptions expect them to, resulting in a higher cost and the need to manage risk longer than anticipated.

A longevity swap transfers some (or all) of the longevity risk away from the pension scheme to another party, via an insurance contract.

Biggest Longevity Swap Deals Over the Last Decade

Some of the biggest longevity swap deals involving a UK pension scheme over the last decade are shown below:

UK Pension Scheme	Size £bn	Insurer	Reinsurer	Year
BT	16	Captive	Prudential Insurance Company of America	2014
Lloyd’s Bank	10	Scottish Widows	Pacific Life Re	2020
Barclays Bank	7	Captive	Prudential Insurance Company of America	2022
HSBC Bank	7	Captive	Prudential Insurance Company of America	2019
Undisclosed	6	Zurich	Prudential Financial, Inc	2021
Lloyd’s Bank	5.5	Scottish Widows	SCOR	2022
Barclays Bank	5	Captive	Reinsurance Group of America (RGA)	2020
Aviva	5	Aviva	Swiss Re, SCOR and Munich Re	2014
ICL (Fujitsu)	3.7	Captive	Swiss Re	2021
BAE Systems	3.2	Legal & General	Hannover Re	2013
BBC	3	Zurich	Canada Life Re	2020
Undisclosed	2.6	Zurich	Metlife	2021

Commenting on the second largest UK longevity swap deal to-date, the £10 billion longevity swap involving Lloyd’s Banking Group pension funds in January 2020, Andy McAleese, Pacific Life Re, Head of Longevity, said: “Pacific Life Re has been a long-term supporter of longevity risk transfer, having completed the first UK pension scheme longevity swap in 2009.”

2023 has the potential to be the biggest year ever…

Reduced exposure to growth assets and greater interest rate & inflation risk hedging, has focussed attention on the remaining unhedged longevity risk. And with greater reinsurance capacity (including new entrants) driving down the cost, more longevity swap deals are likely to be struck as schemes take advantage of current market conditions.

However, significant improvements in buy-out funding levels for many UK pension schemes, may mean schemes bypass longevity swap insurance and move straight to full insurance. Furthermore, if the U.S. market for pension longevity risk transfer takes off, it is possible that capacity for UK deals could wane.

Commenting earlier this year, Tom Ashworth, Director at WTW, provided his prediction for 2023, saying: “We expect more schemes than previously to consider the use of longevity swaps…I expect a busy year with in excess of £40bn of bulk annuities transacted and £20bn of longevity swaps, meaning 2023 has the potential to be the biggest year ever in the de-risking markets."

Funded Reinsurance

Funded Reinsurance hit the headlines recently following a warning to UK insurers from the Bank of England of the dangers of overreliance on funded reinsurance to meet the surge in demand for pension risk transfer.

Funded Reinsurance involves insurers passing on both longevity risk and asset risk to reinsurers, often in foreign jurisdictions such as Bermuda.

Funded Reinsurance allows UK insurers to write more buy-in and buy-out business but exposes the insurer to the risk of having to pay the pensions without the assets to back them if the reinsurer fails.

One thing is for sure: the pension risk market is showing no signs of slowing down. Whether it’s longevity swaps, buy-ins or buy-outs (funded or otherwise), this market will continue to be buoyant for the rest of this year and for many years to come.

Previous Poll Results…

In Issue 1 of Ask The Actuary, I asked you:

Q. “What do you think will be the solution to the DB capacity conundrum?”

A. 55% of you said: “A new entrant in the BPA market and/or increased insurer/reinsurer capacity.”

Indeed, M&G plc (which owns Prudential) has confirmed it plans to re-enter the Bulk Purchase Annuity (BPA) market later this year, taking the number of BPA insurers up to nine, with other potential new entrants also exploring their options.

Now, It’s Your Turn…

What would you like to know more about?

U.S./Canadian/Dutch Pension Risk Transfer market
Collective Defined Contribution (CDC)
Insurance-linked securities (ILS) including Catastrophe Bonds
Other (please share your request with me at rob.hammond@bwd-search.co.uk)

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