Unusual market conditions sparked RSA longevity deal
UK - The defined benefit pension schemes of Royal & Sun Alliance would likely have been unable to protect their pensioner liabilities with a gilt swap and longevity insurance deal completed earlier this week if market conditions had not thrown the fixed income market into array, suggest officials.
The Royal Insurance Group DB pension scheme and the Sun Alliance pension schemes completed deals with Goldman Sachs and its insurance division Rothesay Life earlier this week to protect almost half of their liabilities from future longevity risk.
The deal is different to the first longevity swap plan secured by Babcock International last month - worth £1bn - as on this occasions trustees and company officials managed to negotiate a new form of asset swap and insurance arrangement which allowed the scheme to secure £1.9bn of its pensioner liabilities without the need for any kind of buy-in or buyout annuity plan.
Instead, said Mike Harris, corporate finance director at the UK life insurer Royal & Sun Alliance, trustees tapped current anomalies in the UK government bonds and sold a series of 10-15-year gilts to Goldman Sachs in return for 30- and 40-year gilts.
The money left over from this transaction was then used to pay longevity swap premiums to Goldman's sister company, Rothesay Life, which means assets do not have to be handed to an external provider and the pension plans are protected against any counterparty risk should either firm collapse in the future.
"The uniqueness of this, relative to other bulk annuity deals, is this has significantly enhanced security as the schemes return the legal ownership of the assets and remain invested in high-quality low-risk assets, such as gilts," said Harris.
"Other deals have counterparty risk and lose some of the assets or they are using riskier assets to generate return for the provider. We have been able to work with Goldman Sachs and swap or gilt portfolio for another longer-dated portfolio, to give an enhanced yield, to help pay for longevity swaps.
"We saved tens of basis points, because the yield has picked up on gilts. And that was used to buy the longevity protection. The ‘juice' of the deal was provided by the asset swap and the sourcing capabilities of Goldman Sachs. So apart from a few transaction costs RSA has not had to put in any additional funding," he added.
The R&SA schemes are unlikely to have been able to protect themselves as securely against the future liabilities of its pensioners without the recent dislocation in the credit markets, noted Harris, as pricing would have made it too expensive to opt for this route.
Trustees, advisers and R&SA officials worked on this deal for a considerable length of time but never anticipated the final outcome would be an asset swap exploiting pricing differentials in the gilts market, according to Harris.
"The [gilt] market itself and what is out there at the moment has made this possible. The unusual relationship between the shape of the gilt curve and the shape of the swap curve has meant the economics of this particular transaction worked at that moment," continued Harris.
"That produced the juice to help pay the [longevity swap] premium. The market has effectively paid for it. We might not have been able to had the market not been this way, but the market is still volatile and there are still opportunities," he added.
Several parties were involved in the transaction on all sides, as the pension schemes' trustees were given actuarial advice from Hewitt and Watson Wyatt as well as investment advice from Watson, while DLA acted as legal adviser to the schemes. R&SA was advised by Towers Perrin and Slaughter & May.
On completing the transaction, Harris said the key driver which made this entire deal possible was the willingness of all parties concerned to consider new ideas.
"One of the things we learned was flexibility. We had been working at it for a reasonable period of time, within dynamic market conditions. And the trustees have been open-minded during the process. The whole spectrum from a single annuity provider right through to this deal was considered, and this is by far and away the better structure.
"Flexibility and open-mindedness were important. When we set out we didn't have this particular goal in mind. But this was cost-effective and provided security for the schemes," he added.
The Royal & Sun Alliance DB pension plans are relatively mature as they have approximately 15,500-16,000 pensioners, 28,000 deferred members and 4,000 active members, and have liabilities of £4bn.
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