The BT Pension Scheme (BTPS) has insured 25% of its longevity risk as re-insurers continue to favour the UK market, with deals breaching the £20bn mark (€25bn) in 2014.

US-based life insurer Prudential Insurance Company of America (PICA) will re-insure £16bn of longevity risk in a record deal more than three times larger than the previous.

A longevity swap sees a scheme make regular payments to an insurance company based on expected mortality rates, with the insurer or re-insurer making payments back equal to payable pensions, thus taking on actual longevity risk.

In a novel approach, the BTPS created a wholly owned insurance company subsidiary, allowing the scheme to access the re-insurance market directly and avoid paying fees to intermediary firms.

Re-insurers only transact with insurance companies or banks.

The scheme then transferred the longevity risk to its subsidiary before re-insuring this with PICA, with the policy forming part of the scheme’s investment portfolio.

Arrangements for the transaction started around two years ago, when the scheme explored available options to reduce the levels of risk.

Frank Naylor, CIO at BTPS, said the traditional methods of using insurance companies, which then in-turn re-insure their risk, did not provide enough capacity for the BTPS to achieve value.

“Because of the size of the scheme, traditional routes were never going to be enough scale to make a difference,” he said. 

“So we creatively thought about how to access the re-insurance market more directly.”

The subsidiary insurance company can also be used to reduce longevity risk further in future.

PICA won a competitive tender after pitching against six other rivals, with appetite for longevity risk allowing the BTPS to go as high as £16bn, despite originally planning less.

Chairman of trustees for the scheme, Paul Spencer, said the BTPS was delighted with how the arrangement worked.

“The transaction significantly reduces risk and provides enhanced security for members,” he said.

Ian Aley, senior consultant at Towers Watson, who advised the trustees on the deal, said that, while pension schemes are turning their attention to longevity risk, appetite from re-insurance markets is substantial.

The need for re-insurers to take on longevity risk comes from a legacy of taking on large amounts of mortality risk, with the addition of longevity risk creating capital efficiency.

Longevity risk now plays a larger part of scheme risks, given the de-risking nature in investment portfolios.

However, a deal of this size again is unlikely given the lack schemes able to shift such huge amounts of risk in single transactions.

“The approach of establishing their own insurers made sense because the BTPS understands the investment techniques involved and because the transaction was so large,” Aley said.

“We do not expect this to become the standard template for transferring longevity risk.”

Aley said predictions for a £30bn market in 2014 for longevity swaps and bulk annuities now seemed insubstantial given the deals seen in the first half.

The previous record for a longevity swap was set by the Aviva Staff Pension Scheme, which transferred £5bn of risk to Swiss Re, Munich Re and SCOR Global Life, using its insurance company sponsor as an intermediary.

Other de-risking deals seen in 2014 include buy-ins between the Total UK Pension Plan and Pension Insurance Corporation worth £1.6bn, and a £3.6bn deal between the ICI Pension Fund, Legal & General and UK insurer Prudential.

Matt Wilmington, partner at Aon Hewitt, which advised BT, the scheme’s sponsor, said: “We have been talking for a number of months about the increasing capacity and appetite of the global reinsurance market to take on pension fund longevity risk.

“Transactions like this and Total’s buy-in, where all of the longevity risk was immediately reinsured, serve to underline the scale of capacity available.”