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IPE special report May 2018

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Towers Watson challenges intermediary insurers in longevity swap market

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Towers Watson has launched a service aimed at removing the need for insurance intermediaries when UK defined benefit (DB) funds transfer longevity risk.

The consultancy has set up ready-made insurance cells, which allow pension funds to deal with reinsurance companies directly in longevity swap arrangements.

Reinsurers only transact with insurance companies or banks, meaning DB funds wishing to hedge longevity risk have to access the market via an intermediary firm.

The move by the consultancy comes after its involvement in advising the trustees in BT Pension Scheme’s (BTPS) mammoth £16bn (€20bn) longevity swap, where it transacted directly with a reinsurance company.

BTPS created its own captive insurance company to transact directly with the reinsurance market and avoided intermediary fees and complications.

Towers Watson’s service, Longevity Direct, will give pension funds access to a “ready made insurance cell”, which it said could write insurance and reinsurance contracts for longevity swap transactions.

This, Towers Watson said, would reduce the costs of entering a longevity swap arrangement by cutting the intermediary fee and removing the need for price averaging.

It said the costs of a typical transaction of £2bn in liabilities could come close to £30m in intermediary costs, with Longevity Direct having the potential to save “several million pounds”.

Shelly Beard, senior consultant at the firm, said DB schemes not being charged price averaging would lead to significant savings.

Price averaging occurs when insurers or banks typically engage with several reinsurers to spread credit and counterparty risks, and exposure limits.

This means pension funds end up paying several levels of fees, which deteriorate as the intermediary engages each additional reinsurer.

However, via a single transaction and where the pension fund is comfortable with a single counterparty, it could select the best pricing in the market.

Beard also said the offering was much more stripped out in terms of intermediary costs charged to pension funds, allowing for further savings.

Keith Ashton, head of risk solutions at Towers Watson, said: “Pension scheme and reinsurer interests are typically very aligned. A direct agreement can be much less complex than the longevity swaps we have seen in the past.”

Longevity swap deals have reached £32bn in 2014 as DB schemes continue to use the insurance market as a prime source of de-risking.

BTPS arranged a £16bn deal – a UK record – earlier this year, directly transferring longevity risk to US-based Prudential Insurance Company of America (PICA).

It transferred its longevity risk to the newly created and wholly owned insurer, which then transferred the risk to PICA, avoiding significant intermediary fees.

The Aviva Staff Pension Scheme also transferred £5bn of longevity risk directly but did this through sponsor and insurance company Aviva.

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