The Merchant Navy Officers Pension Fund has said the use of a captive insurance company halved the cost of its £1.5bn longevity swap, and opened the door for smaller scheme derisking.
The MNOPF’s use of an off-shore captive is the second time this type of deal has been struck in the UK. Last July the BT Pension Scheme announced a £16bn such deal with Prudential.
The fund created its own insurance company in Guernsey, known as an off-shore captive arrangement, and negotiated a reinsurance agreement with Pacific Life Re to hedge £1.5bn of the £2.7bn total liabilities for the 16,000 pensioner members of its post-1978 "new section".
Direct access to the reinsurance market enabled the trustees to make significant cost saving by cutting out the middle man of an intermediary bank or insurer. The fund has derisked all 16,000 of its new section's current pensioner members.
“It could quite easily have cost us £20m or so to go through the traditional route to pass the risk away,” said Andrew Waring, chief executive of the MNOPF. "This structure is significantly less than half of that.”
“For a modest fund of £2.5bn fund we’ve put in place a structure associated with funds of a much different scale,” he added.
In traditional non-captive longevity swap arrangements funds have to contend with paying high fees to take on the credit risk of the intermediary rather than of the insurer.
Derisking process
The MNOPF began looking at the longevity risk across its new section about 15 months ago, Waring said. Mindful of the fund target to reach full funding by 2025, the trustee estimated that over the next six or seven years longevity would represent 80 per cent of the fund’s risk, but deemed there was insufficient capital to pursue a buy-in in the short term.
After talking to a range of advisers the fund pursued a direct access point to the market. The captive insurer, known as MNOPF IC, can pursue future contracts in the reinsurance market to derisk the £100m of pensioner liability that will accrue annually as the scheme’s remaining 11,000 members reach retirement.
Martin Bird, senior partner at Aon Hewitt, said: “With direct reinsurance market access you need to think about the fact that someone needs to do all the calculations, run the administration and operate the vehicle… introducing governance and legal risks and complexities.”
Bird said schemes should, “run a classic cost benefit analysis and question what are the pros, cons and costs of the different structures?”
Martyn Phillips, head of buyout consulting at JLT Employee Benefits, said: “An important consideration is the operational risk of running the insurance company. A 30 or 40-year contract is a long-term commitment to the business you’re contracting with.”
Consultants said they saw the longevity swap market developing significantly over the next with the migration of pension schemes from sponsor management on balance sheet across to the insurance market.
“Longevity swaps are part of a derisking journey along the way to either a completely derisked portfolio or a portfolio that can transmission into the insurance environment,” said Bird.
Shelly Beard, senior consultant at Towers Watson, which advised on the deal, said: “On the supply side reinsurers are very much wanting to take on UK longevity risk to offset and diversify the mortality risk on their books. With both supply and demand it will be a busy few years.”
