On July 4, 2014, the trustees of the BT Pension Scheme in the U.K. announced a record-breaking longevity risk transfer transaction that will provide long-term protection and income to the pension scheme in the event that members live longer than expected.
In an important step for the market, the trustees established a wholly owned insurance company, which has reinsured the longevity risk with the Prudential Insurance Company of America. The transaction covers approximately £16 billion (over $27 billion) in pension liabilities or 25% of BTPS longevity risk exposure.
The BTPS transaction is the largest transfer of pension risk to date and proves that the biggest defined benefit pension funds in the world have a clear and tested path to a lower risk future. They can combine their own world-class asset management with cost-effective longevity risk cover, which is available in the global reinsurance market in the tens of billions.
The innovative structure and approach pioneered by BTPS can be used in any country to prudently manage pension risk. With its immediate relevance to U.S., Canadian and Dutch pension funds, this important transaction represents a watershed moment in a pension de-risking trend that is expanding globally.
The global pension risk transfer market has exceeded $200 billion since 2007 and is experiencing significant growth in the key markets of the U.S., UK, Canada and the Netherlands.
There are over 30 examples of transactions in excess of $1 billion for leading companies like General Motors, Verizon, Rolls Royce, BMW, British Airways, Akzo Nobel and Aviva. These companies have moved to de-risk their pension plans ahead of the growing trend. Many more are preparing to transact soon in the US and abroad to take advantage of favorable market conditions for risk transfer.
Those that act gain a competitive advantage in their industry peer groups and increase the pressure on companies that have yet to reduce pension risk.
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Each of the major transactions completed to date has been tailored to meet the specific needs of the pension plan and its sponsor.
The drive to customize has been crucial to the development of the market because no two companies are the same and no two have the same goals, resources, constraints or definitions of success. Until recently, the role of innovation was to create the basic building blocks for transactions. Strategies were developed to allow pension funds to transfer all asset and liability risks through a buy-in or buy-out.
Alternatives were created to allow the transfer of longevity risk alone or the flexibility to pay for de-risking over time. Innovation has been accelerated by measured increases in longevity and asset losses during the financial crisis. Since 2011, the focus has shifted to innovations that allow the largest transactions (such as BTPS, GM and Verizon) to succeed and innovations that give U.S., Canadian and Dutch pension plans a flexible menu of de-risking solutions from which to choose.
Growing U.S. market
The GM and Verizon buy-out transactions in 2012 opened a new era in the U.S. market. Since then, new pensioner mortality tables in the U.S. show that the average 65-year-old pensioner is likely to live two years longer than expected just ten years ago.
The new mortality tables will increase GAAP liabilities, decrease shareholder value and create a cash call for corporate plan sponsors as funding requirements rise to meet the reality of increasing longevity. Insurance solutions, (including buy-out, buy-in and longevity insurance) remain the only effective means of managing longevity risk for pension funds and many more U.S. companies will transact in order to shed the risk, cost and volatility of maintaining pension exposure.
While BTPS, GM and Verizon are the largest transactions completed to date, leading companies around the world will continue to use insurance solutions to manage pension risks.
As this trend accelerates globally, spurred by the long-awaited recovery of the financial markets and an increasing awareness of longevity risk, another $250 billion in transaction volume is likely.
These transactions will build on the foundation of the pension risk transfer market that we can see so clearly today and will create retirement security for plan participants and a lower risk future for pension plan sponsors.
Amy Kessler is head of longevity reinsurance within Prudential's pension risk transfer business. She is responsible for the launch of Prudentials longevity reinsurance product and has led more than $29 billion in international reinsurance transactions since 2010.
