Situated 120km from Weymouth on the English South Coast, and 50km from Normandy, Guernsey (population 65,000) is a beautifully scenic island with around 50km of coastline and a maritime climate supported by the gulf stream which leads to pleasant summers and mild winters. It is also well known for a regulatory-light insurance regime, leading to the island deriving 37% of its £2bn annual GDP from finance related activities (source: wikipedia).
Of course its this latter feature that has drawn such recent interest in the island from the UK pensions community. Longevity transactions have become big business over the last few years. the website Artemisblog.com documents the dealflow over the last decade showing a steady flow of 4-5 deals per year. 2014 was a particularly bumper year (for a number of reasons that I highlighted in a previous blog here – although funding levels have fallen substantially since then) including the mammoth £16bn deal executed by the BT Pension Scheme.
The BT deal also heralded a new structure for these type of deals: the traditional format was an “intermediated” trade where a UK regulated insurer (such as AbbeyLife or Legal & General) transacted with the pension scheme, with the vast bulk of the risk being transferred on to the offshore re-insurance market. What BT did was to set up their own insurance vehicle (known as a “captive”), domiciled outside of the UK and therefore subject to different insurance regulatory treatment. This vehicle then transacted with the re-insurer (in that case Prudential Insurance Corporation of America). Since then, there has been a rush of new providers to the market offering similar structures set up in a way designed to be accessible to smaller schemes – Towers Watson announced their entry into the provider market with the launch of Longevity Direct solution in January of 2015, closely followed by the MNOPF’s £1.5bn transaction. In February 2015 PwC announced their solution in partnership with Artex risk. The more traditional intermediaries (Deutsche Bank and L&G) also have similar solutions available.
But what questions should trustees and sponsors be asking about this “new breed” of solutions?
1. What happens in the case of insurance regulatory change in the domicile in question ?
We know Guernsey regulation is favorable right now, But what are the obligations of the pension scheme should this change in the future? In what situation could the scheme be forced to provide more capital to the insuring entity?
2. What happens in the case of re-insurer default or deterioration of credit rating?
In the more traditional intermediated solutions the UK regulated insurance entity (AbbeyLife or L&G) typically bears the risk and expense of needing to replace a re-insurer in the event of default event (a risk they are required to hold capital against in the UK regime). Of course re-insurer default is not a likely event by any means, but these are trades of 20 years or more, and a lot can happen over that period of time. Who bears this risk in the offshore captive solution?
3. how many re-insurers does the provider have ability to deal with? Are there any limits in place on capacity?
The price of any solution will be driven by the re-insurers to whom the ultimate risk is being passed – there are around 13 or so re-insurers globally with appetite to write these kind of risks, to ensure best pricing tension it makes sense that as many as possible should be included in the process.
Longevity is a big risk facing many schemes and solutions to help reduce that risk should be welcomed. A growing universe of providers leads to choice, innovation and pricing tension, which is also to be welcomed. However trustees and their advisors need to examine the details of any solution, and ask the right questions.
I hear Guernsey really is lovely this time of year.