Phoenix Group's senior corporate pensions actuary Richard Zugic speaks to PP about how a longevity swap was transformed into a bulk annuity for the PGL Pension Scheme in the first deal of its kind.
Last month Phoenix Group revealed its insurance subsidiary Phoenix Life had successfully unwound an existing longevity swap for the PGL Pension Scheme and converted it into a £1.2bn buy-in.
This innovative transaction could pave the way for other schemes with longevity swaps to be able to turn them into bulk annuities further down the line.
What were the main reasons for converting the longevity swap into a buy-in transaction with the PGL scheme?
For Phoenix Life, this was a great opportunity to bring £1.2bn of very liquid assets (mostly gilts) onto its balance sheet, which could then be transitioned into a higher yielding, matching portfolio, and thereby generate value. For the Phoenix Group, which is corporate sponsor to the PGL Scheme, this was simply another example of working in collaboration with the PGL Scheme trustee, and its advisers, to manage down the risks within the scheme.
Had there always been an intention to try to convert the swap that was agreed for the scheme in 2014 into a bulk annuity?
It always made sense for Phoenix Life to take on the market risks attaching to the PGL Scheme pension liabilities, in addition to the demographic risks, given it already does this very effectively for a large portfolio of individual annuities. - Phoenix Life currently manages £12bn of assets backing those annuities.
However, the timing of the longevity swap conversion had to be right. In preparation for this substantial transaction, it was important that Phoenix had an embedded internal model under Solvency II so that the capital and balance sheet impacts of the transaction were well understood, and that Phoenix was able to get the full support of its regulator, the Prudential Regulation Authority (PRA), for the transaction thereby ensuring execution certainty. These hurdles were cleared in 2016, which paved the way for the longevity swap conversion.
How did the scheme get beneficial pricing for the conversion?
The beneficial pricing arises, partly, from the original 2014 longevity swap and, partly, from listening and responding to the needs of the trustee. Since the demographic risks had previously been transferred to Phoenix Life, the trustee already had price certainty with respect to that cover.
Furthermore, the conversion of the longevity swap was structured as an amendment to the original insurance policy (rather than by setting up a new insurance policy), thereby preserving capital benefits in Phoenix Life which could be shared with the trustee.
Separately, the Phoenix Group has worked closely with the trustee over a number of years to manage down the risks within the scheme. Continuing this process, Phoenix was able to present a holistic de-risking package in parallel with the buy-in pricing. This package met the trustee's requirements for ‘all-risks' cover from point of buy-in (‘all-risks' cover is not usually provided until buyout) and strong collateral protection, making for an overall more valuable solution.
Were there a lot of complexities involved in structuring the deal?
The longevity swap conversion itself wasn't especially difficult to structure. Some of the features of the deal, however, did require careful preparation and sound diligence to deliver an effective execution.
For example, providing ‘all-risks' cover requires strong engagement from both parties. Firstly, in agreeing the detail of exactly what this cover entails. Secondly, in mapping out, performing and interpreting the due diligence needed to understand the risks being taken on and, thirdly, in reflecting those risks in the price.
As another example, Phoenix Life had to plan very carefully its asset on-boarding and transitioning strategy for a December 2016 transaction, knowing that markets are illiquid during the second half of the month.
Phoenix has open, effective, and frequent engagement with the PRA across the full spectrum of regulatory issues, so it was relatively easy to slot the PGL Scheme buy-in transaction into that dialogue. Like other bulk annuity providers under Solvency II, Phoenix Life holds the bulk annuity within its matching adjustment portfolio in order to gain the maximum capital benefit from investing in higher yielding matching assets - a benefit which is then reflected in the bulk annuity price.
Could longevity swap to bulk annuity conversions become increasingly common across the industry?
To the extent that the longevity swap providers have appetite to take on assets and the associated market risks, along with the desire to work constructively with pension scheme trustees to deliver a valuable solution, then it's reasonable to expect that longevity swap conversions will become another source of bulk annuity transactions in years to come.
Just Group has completed a £74m pensioner buy-in with the UK pension scheme of a US-listed engineering business.
The Smiths Industries Pension Scheme has secured a £146m buy-in with Canada Life in its fourth bulk annuity and its sponsor’s tenth overall.
The Prudential Staff Pension Scheme has entered into a £3.7bn longevity swap with Pacific Life Re, insuring the longevity risk of over 20,000 pensioners.
The Baker Hughes (UK) Pension Plan has secured approximately £100m of liabilities through a buy-in with Just Group.
There have now been a total of 30 longevity swaps over £1bn publicly announced. The full list, provided by Willis Towers Watson and through PP research, is as follows...