Italian tyre manufacturer Pirelli’s two main UK pension schemes have agreed longevity swaps covering £600m of pensioner liabilities, as researchers have suggested market volatility and insurer competition mean schemes could see attractive prices emerge on risk settlement products.
Bulk annuities and longevity swaps have seen widespread market interest in recent years, with activity expected to pick up in the second half of 2016 after a cooldown in the past six months.
Most schemes have taken some steps to manage equity and interest rate and inflation risk but most are fully unhedged in this area so it makes sense to, at the right price, target this risk
Andrew Ward, Mercer
The Pirelli General Pension and Life Assurance Fund and the Pirelli Tyres Limited 1988 Pension and Life Assurance Fund both undertook 'named life' longevity swaps with Zurich Assurance, covering the risk that 5,000 named pensioners and their dependants might live longer than expected.
The schemes took a 'streamlined' approach to hedging longevity, exploiting a prenegotiated contract between advisers Mercer and a counterparty insurer, which was then offered to multiple pension fund clients, in order to avoid the costs associated with bespoke solutions.
It is the second significant deal announced in recent months, with the Manweb group of the Electricity Supply Pension Scheme announcing a £1bn transaction with Abbey Life in August.
The group’s UK funds, which are already well hedged against other risks, have seen their collective deficit drop to €91.2m (£77.3m) from €117.7m (£99.9m) at the end of last year.
In a statement, Tony Goddard, pensions manager at Pirelli, said: “The longevity swaps help to improve the security of benefits for all members by removing the uncertainty from members living longer than forecast. They also allow us to retain future investment flexibility.”
Alternative to buyout
Longevity swaps have typically been the preserve of larger schemes, owing to their relatively recent introduction and often highly bespoke packaging, according to Richard Butcher, managing director at professional trustee company PTL.
“It then takes a period of time before an idea becomes mainstream and subject to a consistent approach, and then commoditised such that it’s accessible to a much wider range of potential clients, and then commonplace where it’s accessible to pretty much all of the market,” he said.
He welcomed the innovation seen with the Pirelli schemes, adding that longevity swaps, as part of a self-sufficiency strategy, provide a valuable alternative to buyout or buy-in, which may seem expensive for some schemes in a low-interest rate climate.
“If you’ve got a well matched scheme then market volatility doesn’t matter too much [when considering buyout] but the vast majority of schemes aren’t very well matched,” he said.
Butcher added: “On top of that there’s a limited supply of long-dated bonds, so it’s very unlikely that every [defined benefit] scheme in the land could go to buyout.”
Time to hedge longevity?
Nevertheless, research undertaken by Aon Hewitt this week has suggested that the second half of this year will see significant activity in both the bulk annuity and longevity swap markets.
Michael Walker, principal consultant and co-author of the firm’s risk settlement update, said activity in the first half of the year had been mostly characterised by insurer back-book transactions rather than pension fund deals, which was perhaps a natural cooldown after bumper years in 2014 and 2015.
He said new entrants to the reinsurance market such as Scottish Widows, and greater accessibility for smaller schemes, would ensure competition and attractive pricing.
“We think the market will pick up significantly in the second half of 2016, we’ve already seen some significant transactions and we think that’s something that will continue,” he added.
Price will remain an important factor for schemes considering longevity swaps, especially given the widening deficits experienced by many funds.
But Andrew Ward, principal in consultancy Mercer’s financial strategy group, said schemes should not leave themselves exposed to longevity risk on the assumption a swap would be expensive.
“With one of the Pirelli schemes we looked at, it didn’t impact their funding position at all,” he said.
He added: “Most schemes have taken some steps to manage equity and interest rate and inflation risk but most are fully unhedged in this area so it makes sense to, at the right price, target this risk at least in part.”
