2022 has been another bumper year for longevity swaps.
The total value of business written is expected to exceed £15bn for the third year in a row and with a busy end to the year, it is likely that 2022 will be second only to 2020 (£24bn) in terms of total liabilities reinsured.
We continue to see a focus on larger, £1bn+ transactions - which takes up much of the pricing resources of reinsurers. That, in turn, means smaller schemes still struggle to get reinsurers' attention.
Key factors driving demand
Longevity improvements are arguably more uncertain than ever in the post-pandemic environment, with the medium and long-term impacts of Covid-19 still unknown, and thus strengthening the case for longevity hedging. This is reflected in the longevity swap market, with a strong and stable flow of schemes seeking to hedge pensioner longevity risk.
With scheme funding levels improving in recent years, longevity exposure has become an increasingly dominant risk for many schemes, particularly for those who have already taken steps to reduce their investment risk. The unfunded nature of longevity swap transactions means that schemes retain investment flexibility after entering into a swap, which is an important factor for schemes with illiquid assets and/or limited low risk assets available for annuity purchase.
The longevity swap market has become increasingly competitive and has seen new entrants come to the market, this has resulted in particularly attractive pricing. Schemes taking advantage of this have been able to reduce their longevity risk exposure at a small premium above best-estimate liabilities, and often within long-term funding target liabilities.
Evolution of the deferred longevity swap market
Historically, longevity swaps have focused on pensioner members. However, given the growing number of full scheme buyouts completed over the last few years, reinsurers have continued to develop their capabilities to hedge non-pensioner longevity risk, enabling them to reduce their longevity risk exposure across full scheme transactions.
2022 has shown signs that reinsurers are prepared to extend this non-pensioner longevity risk protection direct to pension schemes via longevity swaps. There are now more reinsurers who are active in the longevity swap market and actively quoting on deferred transactions, albeit with varying requirements (e.g. around the proportion of pensioner / non-pensioners being hedged).
Unsurprisingly, pricing for deferred transactions is still far more varied compared to pensioner-only deals, given the longer duration of liabilities. This, alongside some additional practical considerations for deferred members, adds to the complexity - namely incorporating the various methods of ‘at retirement' and transfer optionality for deferred members.
It remains to be seen how the financial markets will evolve over time. If the current market conditions persist, then schemes faced with lower LDI leverage and higher illiquid asset allocations might turn their attention to longevity swaps rather than opting for a partial buy-in strategy.
We expect the deferred longevity swap market to be a significant growth area for the longevity reinsurance market over the coming years, one which will provide innovative and cost-effective solutions for pension schemes looking to hedge longevity risk across their entire scheme.
However, there are no signs that reinsurer appetite for UK pension scheme longevity risk will subside, and while pricing remains at such attractive levels, longevity swaps will continue to be an attractive risk reduction tool for pension schemes. All of which means the longevity hedging market looks set to remain buoyant in the years to come.
Hannah Brinton is associate partner at Aon
This post is funded by Aon