Analysis: Medical underwriting of defined benefit scheme members to facilitate bulk annuity insurance transactions has taken off over the past two years, but industry experts are sceptical of the benefits of using medical data for scheme valuations.
Medically underwritten deals accounted for 15 per cent of transactions last year, up from 3 per cent in 2013, a recent Pensions Institute report said.
Information on members’ health and longevity prospects provides insurers with in-depth insights into the risks presented by specific tranches of scheme liabilities, and can lead to reductions in transaction pricing.
You want to be sure that you’re likely to transact… there’s very little value in gathering information
Paul Darlow, Xafinity
Data collection company MorganAsh has undertaken large volumes of work on behalf of schemes pursuing a medically underwritten bulk annuity, but reports its services have also been contracted to assess £1bn of pension liabilities purely to help value scheme liabilities.
In 2013 sawmilling business BSW Timber completed a medically underwritten buy-in for all current pensions in payment across its two closed DB arrangements.
Since then, the company has undertaken an additional medical underwriting exercise among the two schemes’ high liability pensioners.
Longevity swaps market gets busy as schemes compete with insurers
Longevity swaps had a busy year in 2015, with transactions totalling £9.3bn according to consultancy LCP’s ‘Pensions Derisking 2015’ report.
Partner at law firm Ashurst Adam Levitt said that more recently some pension schemes have been going directly to reinsurers.
The BT Pension Scheme did just that in 2014, when it entered into a £16bn deal with The Prudential Insurance Company of America by setting up a captive on the channel islands. The Axa UK scheme and RAC (2003) Pension Scheme have done similar deals on a smaller scale.
“Having put risk into that [wholly owned] captive, the captive itself can obtain reinsurance,” Levitt said.
But schemes could find it more challenging to use longevity swaps in the future, said Charlie Finch, partner at consultancy LCP.
“We’re seeing the insurers increasingly use longevity swaps themselves from the reinsurers. So they’re using up capacity,” he said.
“And if you’re a reinsurer would you prefer to do a reinsurance longevity swap with an insurer who knows what they’re doing… or go for a more protracted process with a pension plan who’s doing it for the first time?” Finch noted.
Longevity swaps will still be available for schemes but it will be “a more crowded market”, even though the reinsurance market has grown in the last few years, he added.
Longevity swaps might also stop schemes from doing a buy-in or buyout at a later point, said Francis Fernandes, senior adviser at covenant specialist Lincoln Pensions.
Howard Jones, chief financial officer at BSW Timber, said the process improved the valuation of the schemes’ liabilities.
“The outcome showed a reduction in liability due to mortality of some £5m compared to the scheme actuary’s assumptions for this £40m scheme,” he said.
Andrew Gething, managing director at MorganAsh, said the use of evidence-based medical data would improve the precision of scheme valuations.
“The net effects are very similar to the [medically underwritten bulk annuity market],” with the majority of valuations leading to a reduction in liabilities, he said.
Potential downsides
But Paul Darlow, head of proposition development at consultancy Xafinity, said gathering medical information on members brought some potential downsides for schemes.
“Once you’ve gathered medical information it then prevents you from going to the insurance market and gathering insurance quotes on a non-medically underwritten basis,” he said.
Scheme trustees should “think twice” before gathering medical information on members, he added. “You want to be sure that you’re likely to transact… there’s very little value in gathering information,” he said.
Charlie Finch, partner at consultancy LCP, said the data could be used to more accurately gauge mortality assumptions in scheme valuations but questioned how schemes would be able to effectively harness the findings with their existing resources.
“Most pension schemes and actuaries don’t have the skillset to assess [medical data] – it goes beyond what scheme actuaries do,” he said.
