Early July, BT announced with great publicity that it executed a £16bn longevity hedging deal with Prudential Insurance Company of America.
It is easy to get caught up in the media hype and “heat of the moment reactions” on this mega deal. However, from my time as CEO and CIO of Invensys Pension Scheme, it became clear that trustees need to ask the right questions to find the right solutions for a particular scheme. With this in mind, I try to put myself in the shoes of a pension fund trustee director and wonder:
“What questions should I, trustee, ask my advisers about… longevity?”
What does BT’s mega deal mean for the pension fund industry in general, and more specifically, what can I, and my fellow Trustee Board members, take away from this announcement?
A. Impact on the industry
1. It is the first un-intermediated longevity deal of its kind with a non-insurance company. Does this mean it paves the way to more similar deals, as BT’s success proves it can be done? (BT established a wholly-owned insurance captive that transacted with Prudential Insurance Company of America, a re-insurance company; pension funds cannot transact directly with reinsurers).
2. It does seem however that the structure used by BT is suited only for the largest and most sophisticated pension funds; does this mean the intermediated model experienced to date in the UK will remain applicable to most funds?
3. Does that also mean there is strong appetite from re-insurers for longevity risk hedging at the moment and, if so, how long is it going to last?
4. And finally, should the price to hedge that type of risk therefore remain competitive, at least in the short- to medium-term?
B. What about my fund?
What questions should I be asking my advisers to allow me to make an informed decision on the next step I should be taking in relation to the longevity issue within my fund?
I. Understanding longevity/mortality
4. If he/she isn’t, how can I be reassured that the choice of tables, and any adjustment, are appropriate for our fund?
5. Has the actuary included a margin for prudence and am I comfortable with his justifications?
6. How do the actuary’s assumptions for improvements compare to that used by other pension funds? (that data is usually publicly available through annual reports or through the KPMG survey, for example)
7. Has the actuary illustrated the effects of different mortality assumptions in ways that I can understand and which allow me to appreciate the financial effect on the technical provisions?
II. Understanding the risks related to longevity
Assumptions related to life expectancy are generally based on industry mortality tables. The risk that pension plan members will live longer than expected (based on the assumptions) is referred to as longevity risk.
2. How large is the longevity risk run by the fund, in absolute terms and relative to the fund’s other key risks:
b. Interest rate;
III. Mitigating longevity risks
2. Should I also investigate the consequences of hedging longevity with a non-UK based provider?
IV. Consequences of longevity risk hedging
i. Counterparty risk
ii. Rollover risk
iii. Basis risk
iv. Legal risk
c. Collateral management if transacted through an unfunded structure
d. Personal data risk management
e. Immediate impact on your funding level
If you are a trustee thinking about your fund’s longevity risk, asking these questions to your advisers is a very good place to start.
For more information on this topic, please do get in touch with the team at Redington.