UK Risk Settlement Understanding and Managing Pension Risks Risk Settlement Group Quarterly Update, uary 2012 ket news Despite another rollercoaster year and difficult conditions in many investment markets, ended with a number of substantial risk settlement transactions. Read more later on how Aon Hewitt were lead advisors to two significant longevity transactions: the Rolls Royce deal and, hot off the press, the Pilkington deal. In addition you can find out how Aon Hewitt advised on a trigger based pensioner buy-in deal with the trustees of the TI Group Pension Scheme. This has led to around 11bn risk settlement transactions in, helped by a record breaking final quarter of the year. We shall follow up shortly with the details of these numbers as the final figures are released later this month. In the buy-out market, two well-known schemes provided the year s two largest disclosed transactions: Turner & Newell was one of the first, and largest, schemes to be considered for entry to the Pension Protection Fund (PPF). The T&N scheme completed a 1.1bn buyout (the largest buyout deal seen) with L&G in October. Rather than allowing its sponsor to fall into insolvency, the Uniq scheme structured a deal whereby the scheme took a 90% stake in the business and then completed a successful corporate sale. Rothesay Life provided an 830 million buyout for the Uniq scheme. Both these buyout transactions, completed in quarter 4, secured better benefits than the PPF would have provided. Before full data for quarter 4 is available, the position on business placed up to the end of quarter 3 was as follows: The value of deals placed in Q3 was down to 382 million from 1.4 billion in Q2. The number of deals only decreased slightly, however, from 41 to 36. ket activity remains buoyant, with quotation levels up compared to Q2. Q4 results are expected to be markedly higher, with the projected full year figures likely to be over 4 billion, the level seen in and. The chart below shows all business placed in previous quarters. Value of cases ( million) 4500 4000 3500 3000 2500 2000 1500 0 500 200 1 160 140 120 60 40 20 Number of cases 0 2007 Q1 2007 Q2 2007 Q3 2007 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 0 Value ( million) Longevity Deals Value ( million) Cases 1
In the longevity hedging market, quarter 4 saw the largest longevity hedging deal to date. In ember, the Rolls Royce Pension Fund announced a bespoke 3bn longevity hedging transaction with Deutsche Bank. This was similar in size to the 3bn bespoke hedge we previously arranged for the BMW scheme and in late December the Pilkington Superannuation Scheme announced a 1bn longevity insurance transaction with L&G. Together with the 1.7 billion ITV deal with Credit Suisse and the 1.3billion British Airways deal with Rothesay Life, this marks a substantial development of the longevity hedging market. Overall, whilst has seen substantial market volatility and, unfortunately a further fall in scheme funding levels, the risk settlement market has been very active, reflecting the continued appetite to derisk for many schemes and sponsors. In total the number of pension fund longevity swaps has now risen to 12, covering approximately 16 billion of pension scheme liabilities. Rolls Royce Announce 3bn longevity swap In late ember the Rolls Royce Pension Fund announced that it had completed a longevity swap with Deutsche Bank covering 3 billion of pensioner liabilities. This, together with the BMW longevity swap, is the largest insurance pensions transaction in the UK to date. Longevity risk is increasingly being seen as one of the major unrewarded risks remaining in many pension funds. A longevity swap, such as the one taken out by Rolls-Royce, can be an efficient and cost effective tool to mitigate or eliminate longevity risk particularly for the pensioner population of a pension scheme. Our lead advisors tin Bird and Matt Wilmington advised the joint Trustee/Sponsor working group on all aspects of the transaction. The swap was designed to further enhance the security of all the members benefits and we worked closely with the working group to decide that this was the right approach to take and to ensure that the swap was structured in a way that offered the best possible terms on price, security and other key longevity hedge features. The key features of this longevity hedge included: a bespoke longevity swap covering all 37,000 of the pensioners (and dependants) in the Fund the swap is a derivative contract written with Deutsche Bank the swap is fully collateralised, providing protection against any potential default by Deutsche Bank This transaction, along with others completed in the last year or so, underlines a continued focus on pensions risk management and in particular the use of longevity swaps as a key risk management tool for both trustees and sponsors. Other key aspects of the project undertaken by Aon Hewitt were: using the Aon Hewitt Longevity Model (AHLM) to provide a base best estimate assessment of life expectancy and to quantify the level of risk surrounding the base estimate educating the Trustees and Sponsor on the range of structures and solutions (buy-in, synthetic buy-in, index and bespoke longevity swaps ) available to manage longevity risk carrying out a competitive tender process to select Deutsche Bank as the preferred counterparty, structuring the longevity swap to ensure the Trustees got the best possible terms on price, security and other key longevity hedge features working closely with the Fund s lawyers to ensure the agreed commercial terms were reflected in the final swap documentation advising the Trustees on communication strategy including a member communication once the deal was signed and putting in place a strategy should news of the deal leak early Pilkington Superannuation Scheme Announce 1bn longevity insurance transaction In late December the Pilkington Superannuation Scheme announced that it had completed a longevity insurance transaction with L&G covering approximately 1billion of pensioner liabilities. The contract covers approximately 11,500 pensioners in the PSS, who together account for approximately 60% of the Scheme s total liabilities. Our lead advisors tin Bird, Matt Wilmington and Lynda Whitney advised the joint Trustee/Sponsor working group on all aspects of the transaction. Our work on the project was very similar in nature to the Rolls Royce swap. The key features of this longevity hedge included: the swap is an insurance contract written with Legal & General Assurance Society the swap is fully collateralised, protecting the Fund against any potential default by L&G 2
Trigger-based pensioner buy-in deal Sometimes, schemes may wish to enter into a deal subject to certain pricing being available. Where predetermined pricing triggers are agreed, schemes can benefit from getting ready for a transaction and then being able to move quickly when market conditions are right. Aon Hewitt recently advised the Trustees of the TI Group Pension Scheme on a 150m pensioner buy-in where the client had identified specific assets (a basket of gilts) that they wanted to use to secure the premium and an appropriate trigger point was set, equal in this case to the value of the defined asset pool. When an initial market review was carried out, the price was in excess of this trigger point. At this stage a preferred provider was selected and a mechanism was set up to track the price on a daily basis against these assets. Other steps were also taken to prepare the way for a transaction, including agreeing policy documentation. After a period of several weeks, the price trigger hit the target and a call was held with the client to confirm that the deal should be implemented immediately. The risk was transferred on the same day along with the premium payment in the form of gilts. This innovative trigger based approach ensured that the scheme was able to secure terms at the price that was acceptable, and the careful pre-planning meant that the deal went through as soon as the window of opportunity opened. This approach is seen as an exciting and new method of ensuring that schemes get deals at prices suitable for their requirements. Current Bulk Annuity Pricing Our Bulk Annuity ket Modeller (BAMM) is a monitoring tool to help keep Trustees and Sponsors updated on the level of annuity pricing. We track competitive market pricing for the period since the bulk annuity market opened up to more competition at the start of. We consider pricing relative to the key affordability measures used by schemes, including pricing relative to the value of the scheme assets that would be applied to secure annuities, and pricing relative to a funding basis We have constructed the model based on our knowledge of and activity in the market, which enables us to continuously monitor the pricing of live cases, together with regular pricing feeds obtained from providers for sample schemes. The graph below gives an illustration of what we are currently seeing in this example we have considered the pricing for a group of pensioners against a mix of gilts and corporate bonds. Bulk Annuity ket Monitor 110 105 Affordability Index Typical maturity scheme Pensioner 95 90 85 Disclaimer: The above information is based on the broad characteristics of a model pension scheme and our experience in the bulk annuity market. It is indicative and should not be relied on to determine bulk annuity pricing for a specific scheme or how that pricing changes over time. 2012 3
Relative Pricing Funding The graph below shows relative pricing against a typical funding measure for pensioners, deferred pensioners, and total liabilities from 1 uary to 31 December. A higher level reflects cheaper pricing relative to Technical Provisions. Affordability for purchasing pensioner liabilities has continued to be attractive in recent months, in particular for those schemes backing their pensioner liabilities with government bonds. This is primarily because of the relatively high level of credit spreads currently (the difference in yields between gilts and corporate bonds) insurers are therefore passing on in their pricing some of the excess return they expect to achieve as a result of investing in corporate bonds rather than gilts. Insurers are expecting to start 2012 with a busy workload supported by the continued interest in pensioner transactions. For sponsors focussing on the value of liabilities recorded in company accounts, this value may be distorted by the high prevailing credit spreads, producing particularly low liability valuations as at 31 December as previously experienced by many sponsors at 31 December, following the credit crunch. This will at least for the moment make annuity prices seem higher when compared only with accounting valuations This difference in movement in gilt and corporate bond yields underlines why it is important to consider all relevant valuation measures when approaching a transaction. When looking at any de-risking option, it is clearly important to look to the future as well as the past. A number of market-specific issues notably the changes as a result of the new Solvency II regime, and potential short-term limits in market supply appear more likely to lead to an increase in the level of bulk annuities rather than a decrease in the future. More information on Solvency II is available in our October update. Bulk Annuity ket Monitor 110 Funding Index Typical maturity scheme Pensioner Deferred Combined 90 70 60 50 2012 Disclaimer: The above information is based on the broad characteristics of a model pension scheme and our experience in the bulk annuity market. It is indicative and should not be relied on to determine bulk annuity pricing for a specific scheme or how that pricing changes over time. 4
Provider market consolidation and expansion There has been a recent flurry of activity in the marketplace with respect to the number of providers developing and entering the fray. PensionsFirst has announced its intention to launch a bulk annuity insurer (Long Acre Life) with former Pensions Regulator David Norgrove named as Chairman. Part of its offering will be an option for pension scheme sponsors to invest capital into the insurer to allow them to benefit from any profit that would otherwise have accrued to the insurer. This would be intended to reduce the overall longer term cost of insurance. In addition, Nomura has been building its team, with a view to entering the market in 2012. They are currently in the process of obtaining authorisation from the FSA in relation to the creation of Nomura Life. We see any expansion of the market as positive, particularly if it helps drive development of solutions that fit the needs of schemes and their sponsors. On the consolidation front, following Rothesay s acquisition of Paternoster, the Part VII transfer to merge the two annuity books formally took place on 14 December. This process required High Court approval and sign off from the FSA, to ensure that policyholders rights are protected. MetLife are expected to follow the same path in relation to combining with their Alico subsidiary in 2012. Rothesay Life also agreed a longevity reinsurance contract with RGA UK which went into effect on 1 y. The reinsurance contract will provide benefit payments for the remaining lifetime of pensioners from 10 Schemes held by Rothesay and Paternoster, covering c 1.1 billion of liabilities. A further 450 million of longevity risk was transferred by Rothesay to US-based Prudential Retirement in ember. Insurers also showed signs of rebalancing risks, perhaps in preparation for the new Solvency II regime (despite this being delayed until 2013). There were several substantial longevity reinsurance contracts entered into, where insurers took advantage of pricing in the longevity reinsurance market to hedge their exposure. There were also increasing signs of interest in investments wider than the traditional asset classes backing annuity business ie beyond corporate bonds, gilts and swaps. Contact If you would like further information on the bulk annuity market, please contact your Aon Hewitt consultant. Alternatively contact: tin Bird 0207 939 4610 martin.bird@aonhewitt.com Head of Risk Settlement; or Paul Belok 0207 086 89 paul.belok@aonhewitt.com; or Dominic Grimley 0121 262 5094 dominic.grimley@aonhewitt.com in relation to bulk annuity broking; or Tim Gordon 0121 262 5043 tim.gordon@aonhewitt.com who leads Aon Hewitt s longevity research and modelling group. Aon Hewitt is the global leader in human resource consulting and outsourcing solutions. The company partners with organisations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. For more information on Aon Hewitt, please visit www.aonhewitt.com. Copyright uary 2012 Aon Hewitt Limited. Aon Hewitt Limited is authorised and regulated by the Financial Services Authority. Registered in England & Wales. Registered No: 4396810. Registered Office: 8 Devonshire Square, London EC2M 4PL. Nothing in this document should be treated as an authoritative statement of the law on any particular aspect or in any specific case. It should not be taken as financial advice and action should not be taken as a result of this document alone. SB3155 5