Captive insurance companies are providing pension funds with a valuable avenue to the reinsurance market for transferring longevity risk, said Guernsey Finance, the international finance centre, in a new white paper.
The study, titled 'longevity risk market comes of age', examines how longevity risk – the risk that people live longer into their retirement – has become a growing burden, particularly for closed defined benefit schemes or final salary schemes.
Finding solutions to pension longevity risk has become an area of high growth for Guernsey’s financial services sector ever since the British Telecom Pension Scheme (BTPS) entered into a £16 billion transaction to transfer a quarter of its longevity risk to Prudential Insurance Company of America in July 2014, according to Guernsey Finance. It said that in order to transfer the risk to Prudential, BT established its own captive insurer, a Guernsey-based incorporated cell company (ICC), allowing it to access the reinsurance market directly without paying a bank or insurer to act as an intermediary. The deal was significant, both in terms of its size and its innovative use of an ICC structure.
In the white paper, Paul Eaton, new business director at Artex Risk Solutions, explains that longevity has been hedged by transferring the risk for many years, but the use of captive insurers is a recent phenomenon.
"Historically, commercial insurance companies or banks would be the intermediaries and they would access the reinsurance market to find capacity,” he said.
Eaton added: “What’s happened over time is that the loading intermediaries applied to the transaction have led some schemes to look for a more cost effective way of reaching the reinsurance capacity, and this is where establishing your own insurance company comes into play.”
The ICC has subsequently become the structure of choice, according to the white paper. Each ICC has a core which is owned by the sponsor of the ICC and surrounding the core are a potentially unlimited number of cells, each of which can be set up for separate captive-type business and owned, or licensed, by other parties.
Eaton said the preference for ICCs had been instigated by reinsurers requiring absolute certainty that there is no contamination risk between cells.
“Pension schemes are also aware they may require additional longevity transactions in a number of years’ time, as their portfolio matures, so it helps to have a vehicle that is already in place to which you can add further cells,” he said.
The benefit of going down the captive, or ICC, route, rather than using an insurer or bank to access the reinsurance market, is that it is easier to do business with just one reinsurance counterparty, explained Ian Aley, senior consultant at Towers Watson.