The Ultimate Pension Plan?
Courtesy of Leo Kolivakis
Submitted by Leo Kolivakis, publisher of Pension Pulse.
Just came back from Calgary and I’m tired so will keep this short. First, let me thank Aston Embry and his wonderful family for hosting me on Sunday night. Ashton is the founder of direct-ms.org and is simply a great guy. His wife Joan cooked up a storm (absolutely delicious) and I got to meet two of his sons, their wives and his grandchildren. I truly enjoyed the evening and learned to drop vitamin D pills and go for vitamin D drops which I can add to my morning coffee.
In pension news, Hester Plumridge of the WSJ reports that BMW Drives New-Age Hopes for Pensions:
The U.K.’s pension nightmare is seemingly never-ending. But BMW’s innovative deal with Deutsche Bank to insure £3 billion ($4.64 billion) of its pension liabilities, or the entirety of its pension-drawing work force of about 60,000, against increased longevity, offers hope to companies eager to reduce exposure to volatile pension deficits. It also offers a potential fresh lease on life to the U.K.’s stalled fledgling pension-buyout industry.
During the boom, a number of start-up funds raised money in the expectation that companies would take advantage of narrowing deficits to shed their pension liabilities to an insurer. But the financial crisis caused deficits to balloon again as asset prices fell and bond spreads widened, increasing the value of liabilities. That made a full pension buyout prohibitively expensive for most fund sponsors.
BMW’s deal with Deutsche’s Abbey Life subsidiary gets around this issue by passing on only one element of risk to the insurer: longevity risk. The assets and liabilities, including responsibility for the pension fund’s deficit, last valued at £545 million in 2007, will remain on BMW’s balance sheet, although Abbey Life will assume payments to the pensioners. BMW will pay Abbey Life a fixed premium.
The two parties in the deal need not differ radically in their mortality assumptions for the pensioner group. For BMW, the cost of the deal is likely to be about 5% of the insured liabilities, or about £150 million, but is worth it to reduce the fund’s volatility. Abbey Life believes the premiums it charges will be more than the forecast risk assumed.
Besides, if asset prices recover and bond spreads narrow, there is nothing to stop the car maker from seeking a full buyout in the future. Other U.K. companies will want to take note.
Bloomberg citing the FT, said this is the largest deal yet in corporate longevity insurance, effectively doubling the size of the market. BMW is not the only firm to have recently looked to the longevity swap market as a way of covering the risk posed by people living longer:
Last May, Babcock International became the first British company to do such a swap deal using Credit Suisse as counterparty to hedge 500 million pounds.
Then, in December, Swiss Re undertook a longevity swap in a deal in the UK with the Royal County of Berkshire Pension Fund, which was the first transaction by a public sector pension scheme. The longevity swap covered around 1 billion pounds of its pensioner liabilities.
Consultants Hymans Robertson issued a report on Feb. 17 that predicted the longevity swap market would hit $10 billion in 2010.
Hymans said it expected two other longevity swap deals worth well in excess of 1 billion pounds, which were expected to close in the first half of 2010.
“Premier Foods have been reported to be in negotiations over a longevity swap deal covering around 2 billion pounds of Rank Hovis McDougall’s pension scheme’s liabilities,” the report said.
Deutsche Bank is a member of the newly formed Life and Longevity Markets Association (LLMA). The LLMA wants to transfer the UK’s 2 trillion pounds of pension liabilities to the capital markets to help pension schemes and insurers manage the financial pressure of increased life expectancy.
Hewitt’s Bird predicted another $15 billion in longevity swap deals to come by the end of 2010.
“Most of the capacity of the BMW deal was through reinsurance, but as more standardisation around longevity structures comes into the market, the use of index solutions will increase, which will open up a route veto the capital markets,” he said.
Will longevity swaps take off now that BMW and others have entered into these deals? I believe that companies looking into such arrangements should carefully consider the pros and cons, but it’s clear that if they’re looking to reduce exposure to volatile pension deficits, then such deals may make perfect sense.
Of course, if everyone starts entering into longevity swaps, they may be creating another potential problem down the road without addressing other structural factors that exacerbate pension deficits. In other words, longevity swaps are not the magic pension pill that the media makes them out to be, so buyers beware.
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