Benefits of utilising a captive insurance company to hedge longevity risk include a lower cost base and the guarantee of a 'principal-to-principal' approach between the pension scheme and the reinsurance market, according to pensions funding expert Ian Aley.

Mr Aley, who heads the transactions team at Towers Watson and specialises in advising pension funds and sponsors on insurance-based transactions for de-risking purposes, told a London audience of pension fund trustees and asset managers that the use of captives was an efficient means of dealing with the risks associated with large pension schemes.

He explained that, while cost was a key factor behind using a captive, the fact that a captive allowed pension schemes to maintain control by facilitating a 'principal-to-principal' approach with the removal of third parties in transactions was equally important.

"The appetite for longevity is in the reinsurance market, so you could use an insurer to take the risk and then pass it on, but they will have to apply capital to that risk, even though they are not writing the risk. If you use a captive offshore, such as Guernsey, the capital regime is different and there is a greater level of relief for reinsurance," said Mr Aley.

"The capital that is applied to the captive you can think of in terms of a liquidity issue rather than paying someone else capital. So you still own the captive; you still own that capital. You're not going to be able to use it for many years, but it's still there. So, there's a reason of cost.

"The second reason for me is if you are transacting with a reinsurer directly through the captive, you are able to have a principal-to-principal discussion, rather than have a third party influence the documentation and the terms of the contract. Therefore, it better suits the needs of both parties."

He added that traditional insurance companies acting as an intermediary would have other product lines, potential future business and business they have written in the past to consider.

"Consequently, they are restricted in terms of the level of credit exposure they are willing to take to a reinsurer. So, in reality, if you're doing a transaction of scale, you're now looking at an average price rather than the optimal price," said Mr Aley.

Mr Aley was speaking on a panel session at Longevity – is there life in captives?, an event hosted by Guernsey Finance in conjunction with the Guernsey International Insurance Association (GIIA). Moderated by captive insurance veteran Malcolm Cutts-Watson, the panel consisted of Mr Aley; John Dunford of the Guernsey Financial Services Commission (GFSC); Philip Jarvis of Allen & Overy LLP; Paul Kitson of PwC and Andy McAleese of Pacific Life RE.

Mr Kitson said that the potential impact of life expectancy risk on pension fund deficits and balance sheets was a 'big driver' in why companies were looking to hedge longevity risk. He suggested that over the last 10 years there had been approximately £200 billion added to the liabilities of UK pension funds.

"Some of that of course, is catching up, perhaps, and putting more forward-looking modelling around what's going to happen in the future and future improvements, but clearly one of the reasons why this risk is now regarded as one of the big risks is the fact that it has contributed significantly to liabilities in the past," said Mr Kitson.

"What's going to happen in the future? We're certainly seeing pension funds and their corporate sponsors put a lot more analytics and analysis into thinking about how longevity risk could change and how it could make deficits go both up and down in the future."

The event also included a keynote presentation from John Coles, Head of Operations for the BT Pension Scheme, on how BT structured its record-breaking £16 billion longevity risk transfer with the Prudential Insurance Company of America and why a Guernsey-based structure was used.

Mr Coles said Guernsey's utilisation of the incorporated cell company structure was the most appropriate and practical way of meeting the needs of the transaction.

"The regulator and all of the companies in Guernsey recognise the business activity. They understand the risks and that is very helpful. Guernsey is open for quality business. From our particular experience we have met and now use a number of very experienced and talented people with both insurance and captive knowledge and they have been very adaptable and flexible in helping us to land what was quite an innovative transaction for the scheme – to actually create its own captive, certainly in a transaction of this size."

Sponsors of the event were Artex Risk Solutions, Carey Olsen, Towers Watson and Willis. The event was supported by media partners Investment & Pensions Europe and

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