Bringing something new to the party
Judge’s comment: “A big step to have been able to hedge one of the main liability risks by not allowing itself to be limited by standard hurdles.”
The €3.4bn UK Merchant Navy Officers’ Pension Fund (MNOPF) is firmly committed to finding innovative solutions in pursuit of the trustee’s plan to achieve a full funding level. In December 2014, the trustee of the MNOPF announced a longevity hedge covering £1.5bn of pensioner liabilities, carried out using a ground-breaking approach. This approach has been widely accepted as establishing a path to market that can be followed by many schemes that previously would have been considered too small to viably de-risk in this manner.
The cost of hitherto so-called traditional approaches to longevity de-risking was significant and prohibitive to all but the very largest of pension schemes with the resources to insure huge liabilities. The innovative new approach that MNOPF has identified and implemented resulted in the fund insuring pensioner liability risk at a fraction of the cost than would otherwise have been possible.
The longevity de-risking market is founded on the basis of a pension fund paying an insurer an agreed premium in exchange for the insurer agreeing to meet the pension liabilities of the members this covers. The reinsurance market specialises in this area and ensures competitive pricing. However, UK pension schemes are not permitted to deal directly with reinsurers, so they need to recruit an intermediary. Dealing with a bank or insurer, or creating a capitive insurance company, were the most common options pension funds had at their disposal. But these all bear significant costs.
The approach the MNOPF adopted involved working with a partner to establish a Guernsey-based business to provide a framework for the creation of captive insurance cells, with the cells designed to act as a conduit to pass risk from the pension fund to the reinsurance market. Guernsey is a common location for captives of this kind. The cell provides all of the services required to execute and govern a longevity transaction, which the MNOPF used to access the reinsurance market.
There are two main benefits to this innovative solution. First, under a typical structure, the intermediary insurer or bank will charge between 1% and 1.5% of the liabilities as a commission. The alternative approach of creating and running an insurance company is also very expensive both in set up and ongoing governance. However, the framework governing the MNOPF’s insurance cell ensures set-up and running costs are significantly less of either a commission based deal or managing an insurance company.
Second, when a longevity hedge is completed via an intermediary, it may be spread across two or three reinsurers as the intermediary will have limits on the level of credit exposure it can take with individual reinsurers. This means that rather than getting the cheapest price available in the market, the intermediary opts for the top two or three prices in the market and this can significantly increase the price of the transaction. With the captive cell structure, the best reinsurance price can be typically achieved for all of the covered liabilities. These two factors combined ensured that pricing seemed very competitive, with the result being that the MNOPF was able to insure 50% more liability than it first anticipated.
The reason MNOPF was determined to find an innovative solution to this issue was that the trustees identified that longevity risk was the third biggest risk the fund currently faced after equity and interest rate risk, but that this was projected to become by far the largest risk over the coming decade. Overall, risk in MNOPF has been reduced by around 10% already, with no significant impact on its plan to achieve full funding. This innovative transaction has been a major success for the scheme in securing members’ benefit entitlements without increasing the burden on participating employers.
Merchant Navy Officers’ Pension Fund
Founded in 1938
Defined benefit industry-wide pension fund
- active: 695
- retirees: 16,578
- deferred: 9,214
- one year: 24.7%
- Innovative deal to create a Guernsey-based firm for longevity hedging
- Deal means MNOPF can insure twice the volume of liabilities as initially envisaged
- The new structure has contributed to a 10% risk reduction overall since December 2014
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