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Sunday 20 October 2019

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Following suit

Written by Kin Ly
April 2013

Kin Ly examines to what extent other European countries are adopting the Netherlands’ and UK’s approaches to managing longevity risk

Europe’s increasing life expectancy is welcome news for many as these rates hit record levels, but those at the forefront of managing the rise in pensions liabilities have yet another risk to consider as increasing longevity places a hefty strain – an added 5 per cent in some countries – on liabilities already in their billions.

Such is the case for ‘mature’ defined benefit (DB) markets of the UK and the Netherlands where billions-worth of assets under man-agement have meant that both countries have had to respond with haste in developing longevity solutions. Now tipped as the leading countries for innovation in this area, examples of good practice can be drawn from both markets as other European countries wake up to the impeding challenge.

The Organisation for Economic Co-operation and Development, while acknowledging the difficulty in making predictions on how fast a market for longevity may develop, has identified the UK and the Netherlands as countries that “offer the most promising conditions for this market to take off”.

Its report, A model for longevity swaps: Pricing life expectancy, highlights the countries’ notably large pension funds as a key condition for stimulating a longevity market: “In Europe, the UK and the Netherlands, because of the size of their pension fund markets, would be the greatest beneficiaries of a liquid longevity market.

“Life settlements and mortality cat bonds have been used in the past to transfer very specific forms of longevity risk. Annuity buyouts have also offered some form of risk relief for UK DB pension funds.”

Indeed, recent years have seen a number of buy-ins, buyouts and longevity swap transactions, particularly in the UK, giving businesses a number of solutions for offloading their risks to insurers. Hymans Robertson predicted in its latest Managing Pension Scheme Risk report that before the end of 2017 insurers could take on £100 billion-worth of liabilities from DB pension schemes. Buy-ins and buyouts covered around £4.5 billion of pension scheme liabilities in the 12 months to 31 December 2012; and longevity swaps covered almost £20 billion of pension scheme liabilities since 30 June 2009. Overall, a total of £6.7 billion pension scheme risk transfer deals completed in 2012 and the figure is expected to grow significantly during 2013 and beyond.

However, BlackRock multi-asset client solutions managing director John Dewey adds: “It’s worth noting that even in the UK and in the Netherlands, this is a relatively new market that’s really grown up over the past three to four years. And even now there isn’t really an observable market price despite a lot of effort.

“It’s taken quite a lot of bespoke transactions to get us to the point where longevity swaps have become more commonly considered. The reason for this is that there’s both the supply and the demand. The UK has a large number of more mature pension schemes so longevity swaps transactions are now taking place.”

But in addition to operating significantly large pension funds, there are three other ingredients that make for ‘sensible’ longevity risk management conditions – a well-developed DB pensions market; considerable longevity risk stemming from indexation of benefits; and agreement on longevity assumptions between pension plans and providers of solutions, according to Aon Hewitt partner Matt Wilmington.

“The reason why we see a lot of transactions now in the UK is because all these ingredients work there. We have a lot of DB, we have pensions that are inflation-linked, and we also have an alignment of views [around longevity assumptions] between insurer and pension funds.”

Outside of these markets, Germany has been identified by industry experts as the next big market likely to follow in the footsteps of the UK and Netherlands.

Dewey says while there are marked differences between Germany’s pension system and that of the UK’s, its market has a similar risk focus.

“Germany has a really clear risk focus and a desire to manage the risk that a lot of corporates are seeing on their balance sheets as a result of their pension schemes, but historically there hasn’t been quite as much focus on pension risk management,” Dewey says. “It’s relatively new and normally driven by companies rather than pension fund trustees as is the case in the UK.”

“Before we really see a broadening of these kinds of deals in Germany, I’d expect the UK and the Netherlands markets to become even more developed because there are more natural market conditions there.”

Ireland and Switzerland have also been branded as potential markets for longevity risk management. As these countries reassess their longevity assumptions and start viewing transfer of longevity risk not as a cost related to realigning assumptions, but as a risk transfer premium and begin looking at appropriate solutions “we’ll start to see more transactions outside of the UK”, says Wilmington.

“If we look around the world and ask which countries we expect these longevity solutions to work in – taking into consideration DB pensions and index-linked pensions – then you’ll probably identify Ireland, Switzerland and Germany in addition to the UK and the Netherlands.”

Wilmington explains that because these countries experience similar market conditions as the UK and Netherlands, solutions such as buy-ins, buyouts and longevity swaps bought in to manage the risk of longevity may be applicable to these so-called ‘newer’ markets.

There are of course differences in how pension systems are regulated across the continent, but as Wilmington points out, in general the problems are the same. “It would mean that the solutions that we see in the UK would be applicable also in those countries.

“These are definitely markets that are ready for longevity solutions, as longevity expectations catch up with insurers and the banks that are providing these solutions.”

However in several other European countries, managing the risk associated with longevity is a ‘non-issue’ because the risk of living longer sits with the pensioner.

Robeco head of European pensions Jacqueline Lommen says in some countries there has been a shift away from pay-as-you-go to capital funded pension trusts, which means the financial responsibility of providing for a longer retirement is no longer with the state, but down to the pension institution or insurer, the employer or the individual pensioner.

While some may view these schemes as unfair, recent years have seen the development of a new kind of scheme – smart DC – which aims to bridge the gap between DC and DB.

Lommen says: “What we’re up to now is that we’re not developing traditional DC, where all the risk and responsibility sits solely with the employees – that is not fair. Trustees are now developing smart DC – so you provide your employees with a fixed amount of money each month to put in their pension arrangement but we ensure that the employee is looked after so we have default options to invest your money in.

“Experience tells us that on average 95 per cent of scheme members opt for this default life cycle investment strategy, with only 5 per cent opting out and setting the investment strategy themselves.”

Compared to their neighbours, the longevity risk markets in the UK and the Netherlands may be perceived by some as relatively advanced, with several longevity risk transfer transactions already taking place that have offloaded millions of pounds worth of liabilities to insurers. Indeed we may see similar trends in Germany, Ireland and Switzerland as some industry experts have predicted.

It may well be a case of ‘watch this space’ as Wilmington points out: “When you talk to the providers of solutions, they are also very interested in talking to pension funds in all of those countries and understanding those markets because they’re ready to write their solutions as soon as it makes sense for the clients to do that.”

Kin Ly is a reporter for European Pensions



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