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
"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
"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
Services Commission (GFSC); Philip Jarvis of Allen & Overy
LLP; Paul Kitson of PwC and Andy McAleese of Pacific Life
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
"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."
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