Insurance-linked securities (ILS) has potential in helping counterparties to achieve longevity risk transfer and in financing or backing large transactions for bulk annuity insurers, according to consultants Hymans Robertson.
With the United Kingdom seeking to bring ILS activity to its shores, thanks to the development of regulations for ILS that should be signed into law later this year, Hymans Robertson looked at how this new initiative could impact on the pension risk transfer and life annuities marketplace.
ILS and catastrophe bonds have already begun to be used in a broader range of risks, Risk Transfer Specialist Theresa Chew notes, but two areas of the pension related life market could be particularly suited to being transferred to the capital markets.
First longevity risk, which of course has had its day in ILS some years ago when the longevity trend bond (similar to a catastrophe bond) Kortis Capital Ltd. was issued in 2010 by sponsoring reinsurance firm Swiss Re.
That Kortis bond was never repeated, but there are some longevity related transactions that do take place today, largely involving the ILS fund managers which have life specific ILS fund strategies, some of which are also involved in life structures linked to annuity transactions.
Chew suggested that longevity risk could be a candidate for ILS activity, saying that; “Longevity risk, in particular, is generally well-understood and volatility is relatively low.”
She noted that it is hoped that as the ILS market grows and any activity does occur in the UK, insurance and reinsurance sponsors will use them to transfer an increasingly wide range of risks.
“Bulk annuity insurers could use them to provide additional capital to finance large deals (particularly where reinsurance is expensive or difficult to obtain) or to optimise their capital positions by rebalancing the risks on their balance sheets,” Chew explained.
This is intriguing, as for the right type of institutional or sophisticated investor an ILS bond that effectively augmented the capacity of an annuity insurer, or reinsured a bulk-annuity transaction, could be an interesting.
The usual hurdle of pension funds not being so interested in investing in a risk that they already hold in abundance will of course be an issue for longevity and annuity linked ILS transactions.
But with the ILS investor base broadening all the time and an increasing amount of capital flowing into the market from other sophisticated investor sources than pensions, there is a growing pool of capital for whom longevity or bulk-annuity linked risks might be attractive.
In our Directory of Reinsurance Sidecar vehicles and transactions not one of the entries featured a life insurance or pension related risk, but market participants feel this is one structure that could be used for risk transfer and to bring efficient capacity into longevity or pension risk transfer deals.
But that could change in future, as capital requirements and market pressures push reinsurance firms to offload or seek support in backing the enormous longevity and annuity deals that get done in the market, or as re/insurer managed structures devoted to helping pensions reduce their risk with the support of the capital markets.
A sidecar-like structure could provide an ideal vehicle for reinsurers to bring in third-party capital to augment their ability to underwrite longevity swap and annuity risks.
Whether the impending UK ILS regulations could provide a catalyst to trigger more activity in transferring pension risks to the capital markets remains to be seen, but the UK certainly has the concentration of pensions with significant exposure and the appetite to derisk.
It will be interesting to see whether ILS markets can innovate to provide solutions that meet pension and bulk annuity providers needs in years to come.
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