Using a captive to hedge longevity risk can provide a lower cost base and guarantee a ‘principal-to-principal’ approach between the pension scheme and the reinsurance market, according to pensions funding expert Ian Aley.
Aley, who leads the transactions team at Towers Watson and specialises in advising pension funds and sponsors on insurance-based transactions for de-risking purposes, spoke on a panel session on longevity risk and captives at an event hosted by Guernsey Finance in London.
He told the audience of pension fund trustees and asset managers that a captive is an efficient means of dealing with the risks associated with large pension schemes.
He explained that while cost is a key factor behind using a captive, the fact that a captive allows pension schemes to maintain control by facilitating a ‘principal to principal’ approach with the removal of third parties in transactions is equally important.
“The appetite for longevity is in the reinsurance market, so you could use an insurer to take the risk and then pass it on, but they will have to apply capital to that risk, even though they are not writing the risk. If you use a captive offshore, such as Guernsey, the capital regime is different and there is a greater level of relief for reinsurance.”
“The capital that is applied to the captive you can think of in terms of a liquidity issue rather than paying someone else capital. So you still own the captive; you still own that capital. You’re not going to be able to use it for many years, but it’s still there. So, there’s a reason of cost.”
Aley added that traditional insurance companies acting as intermediaries would have other product lines, potential future business and business they have written in the past to consider.
Malcolm Cutts-Watson moderated the panel, which also featured Aley, John Dunford of the Guernsey Financial Services Commission, Phillip Jarvis of Allen & Overy, Paul Kiston of PwC and Andy AcAleese of Pacific Life Re.
Kitson said that the potential impact of life expectancy risk on pension fund deficits and balance sheets was a ‘big driver’ in why companies were looking to hedge longevity risk. He suggested that over the last 10 years there had been approximately £200 billion added to the liabilities of UK pension funds.
“Some of that of course, is catching up, perhaps, and putting more forward-looking modelling around what’s going to happen in the future and future improvements, but clearly one of the reasons why this risk is now regarded as one of the big risks is the fact that it has contributed significantly to liabilities in the past.”
He added: “What’s going to happen in the future? We’re certainly seeing pension funds and their corporate sponsors put a lot more analytics and analysis into thinking about how longevity risk could change and how it could make deficits go both up and down in the future.”
