Risk Settlement Market 2014 - Aon

Providing you with direction and leadership

Risk Settlement Market 2014

longevity swap transactions totalling

2013

£9billion

Highlights

£7.8billion

of bulk annuity business placed emergence of the

medically underwritten annuity market

Contents Review of the bulk annuity market for 2013

2

Review of the longevity swap market for 2013

4

Longevity hedging – no longer the domain of the big boys

6

Longevity swap structures – the future of intermediation

8

Longevity update – the latest CMI mortality tables

9

10 good reasons for buyout

10

Settlement noticeboard

12

Medical underwriting

14

Risk settlement away from the UK

16

Contact details

17

Executive summary We are pleased to introduce Aon Hewitt’s annual review of the pension risk settlement market, covering bulk annuities, longevity swaps and other risk transfer solutions. 2013 proved to be an exceptionally busy year for risk settlement activity in the UK: It was a record-breaking year for the longevity swap market in the UK, with transactions totalling £9billion It proved to be a significant year for the bulk annuity market with £7.8billion of business placed, the highest volume of business placed in the five years since the 2008 credit crunch 2013 saw the emergence of the medically underwritten annuity market, with a new approach to the pricing of bulk annuities using medical information of scheme members, making the bulk annuity transactions more accessible to schemes of all sizes Further afield, we also saw significant activity: In Ireland, close to €500m of Sovereign annuity transactions were completed accounting for 75% of the Irish annuity market In Canada, where settlement activity is becoming commonplace, we witnessed the completion of a buy-in transaction totalling CA$500m Across Europe and the US we are continuing to see a focus on managing and understanding longevity risk Aon Hewitt’s Risk Settlement Group continues to provide clients with direction and leadership through the varied and complex solutions that exist in these areas. As lead adviser on £8billion of the £9billion of the longevity transactions during 2013 (including deals for BAE, AstraZeneca and Bentley Motors) and some of the most significant transactions in the bulk annuity market (including the £670million buyout transaction for NCR), we have continued to draw on our extensive experience and expertise in this area to help provide clients with solutions that best meet their needs.

As we head into 2014, most schemes are seeing continued uncertainty and volatility in their funding positions and a strong desire to gain more control. It remains absolutely clear that risk settlement remains a key priority for both trustees and sponsors of defined benefit pension schemes. Risk settlement is certainly a key tool in bringing pension stability. We expect there will be a significant volume of settlement deals during 2014, both in the form of longevity swaps and bulk annuity deals: In the bulk annuity market, pricing and available capacity both point towards another bumper year for activity – with over £4bn of Q1 transactions already announced (including the £3.6bn ICI deal in March 2014) The longevity market continues to develop at pace, for both smaller schemes (with new simpler solutions emerging to make access to the market possible) and for ‘mega’ funds (where the focus remains on how to access the reinsurance market in the most direct and efficient route possible) This year we are also excited to launch two new Aon Hewitt services: A unique solution for accessing the new and competitive medical underwriting market in a fast and efficient manner. By combining our proven bulk annuity expertise and our market leading enhanced individual annuity broking platform, we are able to deliver the maximum price saving available from this rapidly emerging market A new ‘implemented annuity’ service for those schemes who wish to delegate the process of purchasing a bulk annuity. The new service offers a streamlined broking process including bespoke price tracking and transaction trigger points and a cost efficient and smooth asset transition process – all designed to allow trustees and sponsors to focus on the key decisions in a bulk annuity transaction without the worry or hassle of what can be a complicated project. Launching this service is very much part of our focus on implementation being as important as strategy If you would like to know more about Risk Settlement, please speak to one of the team or your usual Aon Hewitt contact.


1

Paul Belok

Review of the bulk annuity market for 2013

2013 saw a 65% year on year increase in bulk annuities placed – £7.8bn, compared with £4.7bn Review of the bulk annuity market for 2013 [2 page spread] in 2012. This represented a new post-Credit Crunch almost matching record year 2013 saw apeak, 65% year on year increase in the bulk annuities placedof - £7,782m, compared w 2008 million whichin saw of bulka new annuities placed. £4,728 2012.£8.1bn This represented post-Credit Crunch peak, almost matchin record year of 2008 which saw £8.1bn of bulk annuities placed. £9,000m

Total Value of Business Placed

£8,000m £7,000m £6,000m £5,000m £4,000m £3,000m £2,000m £1,000m £0m 2006

2007

2008

2009

2010

2011

2012

2013

Year

As in 2012, three insurance companies took the majority of the bulk annuity business for As in 2012, three insurance companies took the majority of the bulk annuity 2013. It was the same this yearin– both PIC, years Rothesay and Legal business for 2013. It was companies the same companies – PIC,Life Rothesay Life & General, b and Legal & General – but their combined share increased from 74% to 90% their combined share reached 90% for the year. The graphs below showinthe unusual 2013. The graphs below show the unusual concentration of business placedfor in the five post cr concentration of business placed in 2013, and the longer term picture 2013, and the longer term picture for the five post-credit crunch years. crunch years. Lucida MetLife

Other

Partnership

PIC

MetLife Partnership Prudential Aviva

Other

PIC

Prudential L&G

2009 - 2013

Aviva

L&G

2

Aon Hewitt

2013

Rothesay Life

Rothesay Life

Several trends were noticeable in 2013

Provider changes

Buyouts are back – In a market that had become dominated by pensioner only transactions, the largest bulk annuity deals in 2013 were full scheme buyouts – for the EMI scheme (£1.5bn) and NCR (£670m), both secured with PIC. We advised the company on the latter transaction, and found that better than expected market pricing and improving funding positions from more positive investment market conditions were both important drivers for this and other schemes.

The bulk annuity market has also seen considerable restructuring over the last year.

Full risk transfer is available – Legal & General, PIC and Rothesay Life all offered ‘full risk transfer’ on some large 2013 buyouts – where the insurer takes on residual risks, including the risk that the final cleansed data set turns out to be different from that used for pricing. Bulk annuity programmes – Several larger schemes are now on a derisking programme, where pensioners will be secured in tranches over several years, to accommodate the scheme’s investment strategy and maturing. For example, we secured the first tranche for GKN in early 2014 (£123m), and the fourth tranche for a TI Group scheme (£170m) in 2013, taking their insurance to over £800m.

Rothesay Life had broadened its shareholders at the turn of the year, with Goldman Sachs selling 64% of its holding to three other financial institutions. Rothesay Life is also in the process of adding MetLife’s £3bn backbook to its portfolio in 2014, taking it to a similar size (around £10bn, including the backbook previously acquired from Paternoster) to PIC. Legal & General acquired Lucida Limited during 2013, with a £1.4bn backbook of bulk annuity contracts. This is excluded from our figures above. PIC is of a size to consider an IPO to broaden its shareholders from the current range of private institutions, noting the experience of Partnership and Just Retirement who both completed partial IPOs in 2013. PIC has stated that its shareholders have discussed a potential future IPO but at this stage there are no firm plans to proceed. At present the market is polarising into a traditional bulk market of well established providers, and a new market (focused on smaller deals for now) in medically underwritten annuities. In 2013, the medically underwritten approach gained material ground, with specialists Partnership and Just Retirement both writing deals, and L&G and Aviva competing in this area. Other providers are considering launching rival offers. The 2014 Budget announced pension tax changes, which are expected to restrict the growth of the individual annuity market as members with defined contribution pension arrangements will no longer be compelled to buy an annuity. This is likely to push some insurance companies to focus more of their efforts on the bulk annuity market, and which could further underpin the competitiveness of the market.


3

Martin Bird

Review of the longevity swap market for 2013

2013 was a record-breaking year for the longevity swap market, with £9bn of liability covered. Aon Hewitt is proud that it was the lead adviser on £8bn of these, re-confirming our market-leading position. It was a year of two quarters of activity sandwiching a quiet summer. In the first quarter, two transactions completed; the initial BAE Systems deal with Legal & General, and the deal between the Bentley Motors scheme and Abbey Life (the Deutsche Bank-owned insurer) Both of these deals were notable for their size – being the largest and smallest transactions to date. The BAE Systems deal at £3.2bn continued to demonstrate the ability of the reinsurance market to absorb large deals, and the Bentley deal (at £400m, roughly half the size of the previous smallest deal) showed the scope for bespoke longevity hedges at smaller scheme sizes The final quarter saw another flurry of transactions completing in December, including the deal between AstraZeneca with Deutsche Bank and further deals between BAE Systems and Legal & General (comprising four additional contracts). The BAE deals were notable in that they involved both CPI linked benefits and the complexities of a formally sectionalised scheme The busy end to the year quashed a number of reports that the longevity swap market was shrinking and concerns over capacity constraints. Market momentum has continued into early 2014, with the £5bn Aviva pension scheme completing a transaction with its sponsor acting as the intermediary to the reinsurance market.

2013 deals Date

Fund

Provider

Approx size

December 2013

BAE Systems

Legal & General

Total £1.8bn (across two schemes)

December 2013

AstraZeneca

Deutsche Bank

£2.5bn

December 2013

Carillion

Deutsche Bank

Total £1.0bn (across five schemes)

Bentley Motors

Abbey Life / Deutsche Bank

£400m

BAE Systems

Legal & General

£3.2bn

March 2013 February 2013

* Shaded deals are those on which the Aon Hewitt Risk Settlement Group acted as lead adviser.

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Aon Hewitt

Market capacity While there have been a number of withdrawals from the intermediary market over the last couple of years, the reinsurance capacity has increased substantially. This is both in terms of the number of providers (we now have over 15 providers in the market) and the appetite they have to do business. On most deals there are 10+ reinsurers interested, each with £0.5bn or more of capacity – and in some cases several billions to put to work. The good news for pension schemes is it is these reinsurers who are driving market pricing and capacity. The increased volumes continue to allow deals to be done on attractive terms – even for the multi-billion ‘mega-deals’.

Market appetite for non-pensioner longevity risk All of the deals completed in 2013 hedged longevity risk for current pensioners and dependants in payment, with the LV= / Swiss Re transaction at the end of 2012 remaining the only deal to date which also covered older deferred members. However, the lack of deals covering deferred liabilities during 2013 does not necessarily indicate that this option is not worth exploring. The reinsurance market is now much more familiar with UK pension schemes (and their idiosyncrasies; indexation bases, member options etc) and their longevity risk. As a result, the terms available for hedging of longevity risk relating to deferred members are beginning to look more attractive and it is now possible to structure a swap to cover future retirees on an accurate basis. We expect schemes to increasingly explore the option of hedging older deferred members alongside current pensioners where there are a sizeable proportion of liabilities in this group.


5

no longer just the domain of the big boys

To m S c o t t

Longevity hedging

In 2013 the Bentley Motors/Abbey Life £400m deal demonstrated that longevity swaps could be accessed by sub-£1bn schemes. However, the 2013 market remained focused on larger schemes. This is partly because of the fixed set-up costs associated with bespoke longevity swaps, and the required ongoing management processes and resulting costs. The good news is that the outlook for the 2014 market looks a lot rosier, with increasing opportunities for smaller schemes to access the market. First of all, during 2013 there was the re-birth of index-based longevity hedging, with the launch by Deutsche Bank of its Longevity Experience Options (LEO) solution. Index-based hedging has its limitations – in particular due to the associated basis risk – but if pricing proves to be attractive compared to the level of risk reduction this may find a home, for example at the smaller end of the pension scheme market. Basis risk arises because the mortality experience and changes in life expectancy of a particular scheme may not be in line with the England and Wales population sub-set on which the index hedge is constructed. This is in itself something which is very difficult to quantify. This does not arise with bespoke deals which provide indemnity cover, where the contract is based on the scheme’s specific membership and mortality experience. Secondly, providers have been working hard to develop standardised and simplified bespoke longevity swaps, to use their learnings from the big deals over the last couple of years to streamline the process and make these accessible and cost effective for small schemes. In particular, Legal & General have developed a longevity insurance product, which could be suitable for liabilities as small as £50m. The structure of this is the same as the bespoke longevity swaps seen at the larger end of the market to date: The scheme and the provider agree a ‘fixed leg’ set of cashflows which the scheme is obliged to pay to the provider, irrespective of the scheme’s actual mortality experience of the in scope population – these cashflows essentially reflect the best estimate benefit cashflows, plus the insurance premium In return, the provider agrees to pay to the scheme a ‘floating leg’ set of cashflows which reflect the actual changes in the scheme’s membership

6

Aon Hewitt

Various simplifications are made, to reduce provider and pension scheme requirements and costs – both at outset with the structuring and set-up of the swap, and also in relation to its ongoing maintenance. But crucially this remains indemnity cover, without the basis risk issues discussed above. Provided the pricing and terms of this product are reasonable (in particular the terms enabling the scheme to convert this contract into a bulk annuity at a later date), this is a really exciting market development which we expect to be of interest to many sub-£500m schemes, particularly where hedging through bulk annuities is not currently affordable.

Index-based solutions – a re-cap The first longevity index was launched in 2008 (JP Morgan’s LifeMetrics index) with the intention of providing an approximate longevity hedge for pension schemes based on sub sets of the England and Wales population. However, index longevity hedging solutions failed to take off. This was primarily because the pricing available for indexbased contracts did not prove to be any better (and in many cases proved worse) than that available for indemnity cover from a bespoke longevity swap. In effect, schemes were left with the choice of paying more for a less effective hedge. During 2013, Deutsche Bank – an active player in the bespoke longevity swap intermediary market – launched the Longevity Experience Options (LEO) index-based solution.

In order to reduce the cost, LEO includes a cap and a floor on the longevity risk protection: If population mortality experience is only slightly lighter than expected (slightly more people survive than expected), there isn’t any pay out to the scheme If population mortality experience is much lighter than expected and population life expectancy increases significantly, the pay out to the scheme is capped LEO therefore provides a partial hedge of realised increases in population life expectancy, providing limited mitigation against the more extreme increases in life expectancy, and only reflects changes to actual mortality rates over a fixed 10 year period without any forward looking projections. Situations could therefore arise where the mortality experience over the course of the 10 year contract is relatively heavy, but nevertheless future longevity expectations increase. For example, this might be in the event of some form of pandemic (or just a series of very cold winters), but coinciding with medical advances which significantly reduce expected future mortality rates (and hence significantly increase future life expectancy). The key question is therefore how effective is a LEO-based index longevity hedge, and is the cost of this hedge good value for the partial risk reduction achieved? This remains to be answered, and time will tell whether this approach gains significant traction – particularly if indemnity cover becomes accessible to smaller schemes.

LEO is again an England and Wales population-based product (with a Netherlands equivalent for the Dutch market), with contracts being built on five year age banded cohorts of males or females.


7

Longevity swap structures the future of intermediation The traditional structure of a longevity swap has been for the pension scheme to contract with an intermediary. The intermediary then passes on most (if not all) of the longevity risk to reinsurers or to the capital markets. To date, the longevity risk has mainly been passed through to global reinsurers, with around 20 reinsurers actively participating in the market. Reinsurers Pension Fund

Intermediary Capital Markets

The intermediary has three roles: It transforms reinsurance capacity for longevity risk into a form which pension schemes can transact with It provides the scheme with protection against the credit risk associated with the reinsurers (the intermediary is the sole contractual counterparty to the pension scheme, with the intermediary usually retaining the credit risk associated with the underlying reinsurers) It provides various administrative services, for example payment and collateral calculation services, managing payment transfers (of the fixed and floating leg payments), and posting and receiving collateral To date, intermediaries have been commercial organisations (such as Credit Suisse, Deutsche Bank, Legal & General and Rothesay Life) who charge a fee for their services. This fee typically represents a sizeable proportion of the overall hedging cost. Pension schemes are increasingly exploring alternative structures to limit the costs of third party intermediation. This is particularly the case for larger schemes, where intermediation fees might be £50m or more and where economies of scale might make it more cost effective to cut out the middle man. However, pension schemes cannot directly contract with most reinsurers, and therefore they must access this market via an intermediary. A small number of schemes may be fortunate enough to have a sponsor who is able to act as the intermediary – this was the case with the recent Aviva pension scheme deal, where the sponsor is an insurance company with the required in-house expertise to structure and manage this risk. But for the majority of schemes, this is not an option. A number of potential alternatives are available – from changing the role of the traditional intermediary to make it more cost effective, to employers effectively replicating Aviva and setting up their own captive insurance vehicles especially for this purpose. While it is unlikely to become a mainstream solution, it is likely to merit consideration for the mega funds wishing to access the market in the most cost effective way. This is an exciting market which we expect to develop over the coming year.

8

Aon Hewitt

Longevity update the latest CMI mortality tables

The world of longevity continues to surprise. 2012 and 2013 were both surprisingly heavy mortality years for the UK, i.e. there were significantly more deaths than expected. If we simply run that data through the standard actuarial longevity projection model and use its predictions for actuarial valuations without any further adjustment, liabilities would appear to decrease by over 2%. This may not sound much compared with some other sources of risk, but it is a lot of longevity risk for such a short period of time, especially as there is no obvious external driver. And this is just the tip of the iceberg because longevity risk is all about trends. If this information were to influence actuaries’ views on long term longevity improvement rates, then the impact could be considerably more – an apparently tiny shift in long term improvement rates of just 0.25% p.a. can change liabilities by 3%.

So, while actuaries are still generally predicting continued improvements in life expectancy, a measured approach is therefore called for. The Continuous Mortality Investigation (CMI) is the body owned by the Institute and Faculty of Actuaries that is responsible for producing standard mortality tables and projections for the UK actuarial profession. The CMI’s projection model, which underpins so much of UK pension scheme liability valuation, has proved immensely popular and has emerged as the benchmark against which actuarial professions around the world compare their own longevity projection models. However, the model dates from 2009 and the world has moved on since then. Actuaries with deep longevity expertise are now commonplace in the UK and the CMI projection model will be under the spotlight as a result of this new data. It will be interesting to see how the CMI responds. The one constant in all of this, is that future longevity is genuinely uncertain, no matter how much modelling you do.


9

10 good reasons

for buyout For many schemes, the sponsor and trustees have recognised their goal as buyout. The number of schemes seeing this as realistic in the short term fell in 2008, after the Credit Crunch hit funding levels. We expect full scheme buyouts to increase over 2014, as by the end of

10 Good Reasons for buyout [2/3 page spread] 2013 many schemes had reached their most favourable solvency position

since the Credit Crunch.

For many schemes, the sponsor and trustees have recognised their end goal as buyout. The number of schemes seeing this as realistic in the short term fell in 2008, 1. Improving economic environment after the Credit Crunch hit funding levels. We expect full scheme buyouts to increase over 2014,from as by the end of 2013 many 2013 saw some welcome respite the low yield environment, as gilts schemes had reached their most favourable position since the Credit yields started to rise fromsolvency record lows and equities rose. TheCrunch. improvement

in buyout deficits was material, with funding levels increasing by as much 1. Improving economic environment as 10% from market conditions in the last three quarters of 2013 and

further still from whenthe the prevalence of deficitascontributions beingtomade 2013 saw some welcome respite low yield environment, gilts yields started rise is from record lows, andtaken equities rose. The improvement in buyout deficits was material,ofwith into account. The graph below illustrates the impact market funding levels increasing by as much as Sustained 10% from market conditionswill andtrigger furthermuch still when the conditions alone. improvements more prevalence of deficit contributions being made is taken into account, in the last three quarters buyout activity. of 2013. The graph below illustrates the impact of market conditions alone. Sustained improvements will trigger much more buyout activity. Buyout funding level Buy-in funding level

Buyout funding level progression Buy-in progression Typicalfunding maturitylevel scheme

Strategy 1 (80% equities, 20% gilts) Strategy 2 (50% equities, 50% gilts)

Typical maturity scheme

75%

70%

65%

60% Jan 13

Feb 13

2. Legacy issue

Mar 13

Apr 13

May 13

Jun 13

Jul 13

Aug 13

Sep 13

Oct 13

Nov 13

Dec 13

Jan 14

Feb 14

2. Legacy issue

Closed schemes are only going to get more mature, and companies are increasingly seeing Closed as schemes are2008-2013 only going tohence become more mature, andupcompanies their defined benefit scheme a legacy. has been a period of pent arequestion increasingly scheme as a legacy. 2008demand for buyout, the beingseeing "when"their ratherdefined than "if"benefit for some schemes. 3. Trendsetters

2013 has been a period of pent up demand for buyout – the question being ‘when’ rather than ‘if’ for some schemes.

After a period when pensioner buy-ins dominated the bulk annuity market, some high profile buyouts occurred in 2013, for NCR and EMI for instance, following the groundbreaking GM and Verizon bulk annuity deals in the US. Other companies will take note of the big buyout potential shown. They won’t want their competitors to be de-risked before they are! 4. M&A activity rising A partial economic recovery could signal a material increase in corporate transactions – always a driver for buyouts, as we have already seen for some clients in 2014, as companies look to tidy their liabilities. 5. Deferred premiums

10

Aon Hewitt

Mar 14

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After a period when pensioner buy-ins dominated the bulk annuity market, some high profile buyouts occurred in 2013 (including NCR and EMI) following the groundbreaking GM and Verizon bulk annuity deals in the US. Other companies will take note of the big buyout potential shown – already in 2014 we have seen the £3.6bn ICI deal demonstrating the significant market capacity.

Over 2011 and 2012, schemes adapted their benefit commitments to take into account the Government’s adoption of the Consumer Price Index (CPI), in place of the Retail Prices Index, for inflation-linking statutory pension increases. It has taken time for market pricing to show the ‘CPI saving’ from this less expensive inflation measure, but some savings are now being achieved more consistently and at greater levels on the largest transactions.

0 $DFWLYLW\ULVLQJ A partial economic recovery could signal a material increase in corporate transactions – always a driver for buyouts, as we have already seen for some clients in 2014, as companies look to tidy their liabilities.

'HIHUUHGSUHPLXPV Annuity providers are offering a great deal of flexibility in contract structure to encourage early buyouts, and a key offering is to materially defer meeting part of the premium payable. The premium instalments can then fit in with a scheme’s existing deficit recovery contributions, allow scheme assets to be de-risked gradually or accommodate a future increase in liquidity for the employer. This makes buyout within reach earlier.

5HPRYLQJEHQH¿WEDUULHUV Some types of pension increases are unreasonably expensive to secure – reflecting the difficulty of hedging these risks in the investment markets. Schemes are increasingly exploring the scope to replace pensions with complex increases with a simpler benefit structure, for all members. This may be achievable without taking anything away from the value of members’ entitlements, but with buyout still brought financially into reach, due to the difference between the reasonable value of these increases and the distorted market cost of hedging them under relatively illiquid swap contracts. This requires agreement from the trustee’s legal and actuarial advisers, but is being actively considered to make some current transactions more achievable.

*HWVWDELOLW\DIWHUWKHUROOHUFRDVWHU As schemes have recently experienced increases in their funding levels, they will seek to get stability – not wanting the risk of repeating the funding roller coaster ride of recent years. For some, they may not have time (or resources) to play out another similar financial cycle. Whilst securing selected tranches can be a contributor in stabilising funding positions, full buy-out gives absolute stability.

$QQXLW\UHIRUP The Government’s 2014 Budget changes have been widely publicised as negative for annuity providers, or at least for individual annuity sales. But they also make DB schemes less attractive than DC schemes, as DC benefits are becoming more accessible – potentially bringing forward complete closure and buyout of DB schemes. And they provide an incentive for providers to focus more on promotion to the bulk annuity market, as the scope for individual annuity sales will now be perceived as lower. The budget also increased the scope for smaller benefits to be completely exchanged for cash – in different circumstances this is possible for benefits for up to £10,000, £18,000 or £30,000. It gave an incentive to considering transfers, specifically the short term before possible government restriction on final salary schemes in 2015. If these options are taken up, this could leave schemes with a smaller population left to secure under annuities.

7KHWDUJHWJHWVHDVLHURYHUWLPH For schemes that cannot yet afford buyout, some risks must be borne, but the good news is that in real terms, a buyout target tends to get easier over time. For example, on buyout, the market cost of the inflation risks represented by the scheme’s pension increases must be met, but in the meantime, the true and potentially lower level of actual short-term pension increases is met. The uncertainty over the risks associated with nonpensioners reduces as more members retire, and also give up part of their benefits for cash at retirement. This gradually takes some cost elements out of the pricing for the risks in the scheme, and can help to bring buyout within reach.


11

Settlement noticeboard Cheque writing distance Falls in the shortfall of scheme assets, relative to buyout costs, encourage sponsors to assess cheque writing distance. This can be seen as the amount worth paying to secure a scheme, from assessing the value of removing all future running costs, levies and investment costs, the management time involved and the risks borne. This amount can be material, and means that many schemes got a lot closer to cheque writing distance in 2013. Many of the same schemes considered, but did not quite have time to proceed with, bulk annuities in 2008, before the Credit Crunch damaged their funding positions. Maybe 2014 will prove to be the year the cheque is cashed.

Corporate accounting issues At the 2013 year end, we witnessed much greater flexibility in relation to accounting for risk settlement transactions, in terms of both bulk annuity and longevity swap deals. To date, significant impact on the corporate balance sheet and/or P&L position has proved to be a barrier for many transactions. But with greater flexibility going forward, we expect this to generate further interest and activity.

Settlement readiness In 2012 Aon Hewitt launched a ‘settlement readiness’ assessment whereby any scheme in the country can fill in 20 multiple choice questions and receive an assessment of how well prepared they are to transact, if the terms are attractive. As we start to head into what we expect to be a bumper year for settlement transactions, those who are best prepared are more likely to get the deal done, while those who are least prepared risk missing the opportunity. For a free assessment of how well prepared you are, visit: http://www.aonhewitt.com/settlementreadiness

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Aon Hewitt

To m S c o t t

New for 2014 Implemented annuities As bulk annuity transactions have become more commonplace, the market has responded with various streamlined and standardised advisory and broking offerings. We are taking this to the next level with our Implemented Annuities solution, within Delegated Consulting Services – our market-leading fiduciary investment management. This is driven by our belief that good strategy is only as good as implementation. This solution takes the pain out of the annuity purchase process for schemes with assets invested via Delegated Consulting Services, with: Bespoke price tracking Trigger-based transactions Clear advice and upfront preparation Streamlined broking process Pre-agreed contract terms and associated legal advice Full insurer due diligence service Enhanced insurer engagement and co-operation Cost-efficient and smooth asset transition, from the Delegated Consulting Services platform to the insurer For more information, please speak to one of the team or your usual Aon Hewitt contact.


13

Medical

underwriting 2013 saw the emergence of a new approach to the pricing ofspread] bulk annuities. From a standing Medical underwriting [2 page start, close to £100m of business was written using 2013 saw the emergence of a new approach to the pricing of bulk annuities. From a standing medical information of scheme members to help start, close to £100M of business was written using medical information of scheme members inform insurer views of their longevity. to help inform insurer views of longevity. Indeed,underwriting with medical able underwriting ablethe to change cost of a bulk by up to 10% Indeed, with medical to change cost ofthe a bulk annuity by up to 10%in–discount equivalentrate to afor 0.5% p.a. change in discount equivalent to a annuity 0.5% p.a. change pensioner members – this could have rate for pensioner members this couldapproach have wide long reaching wide reaching implications on how some– trustees termimplications financing and flight on how some trustees approach long term financing and flight plans for plans for their schemes. their schemes.

This market looks set to become a key consideration is any risk settlement discussion for This market looks set to become a key consideration is any risk settlement schemes wherediscussion either: for schemes where either:

There less than 400 pensioner members, collecting There are less thanare around 400around pensioner members, where where collecting medical medical information might be information practical; ormight be practical

There is a concentration ofwhereby risk to asecuring small collection of members with large benefits, large benefits, these members could materially whereby securing these members could materially reduce the risk. reduce the risk

There is a concentration of risk to a small collection of members with

10 9

Cumualtive liability (£M)

8 7 6 5 4 3 2 1 0 0

100

200

300

400

500

600

700

800

900

1000

Number of members

In this 1,000 member pensioner population, a buy-in fora the largest members could In this 1,000 member pensioner population, buy-in for the100 largest 100 capture half of the risk members could capture half of the risk With around one-third of schemes having half of their liabilities associated with just 10% of members, "top slicing" of the highest liabilities can be an effective way to target the riskiest members. Of course, this approach will not necessarily be right for all schemes - by definition, around half of members will be healthier than average. Trustees having an insight into the health of their members with large liabilities may inform whether to investigate this further. But this, in itself throws up challenges for insurers… In the individual annuity market, we understand that many insurers have changed their normal pricing models for customers approaching them for an annuity – thinking that there is a good chance that the member has already considered a medically underwritten price, not taken it and hence may be relatively healthy. There is a fear of a similar change in the bulk market, pushing up the price of traditional bulk annuities for smaller schemes.

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Aon Hewitt

There are currently four insurers prepared to quote for bulk annuities using medical underwriting. Just Retirement and Partnership have brought their expertise from the individual enhanced market joining well established bulk annuity providers Aviva and L&G. Over time,

With around one-third of schemes having half of their liabilities associated with just 10% of members, ‘top slicing’ of the highest liabilities can be an effective way to target the riskiest members. Of course, this approach will not necessarily be right for all schemes – by definition, around half of members will be healthier than average. Trustees having an insight into the health of their members with large liabilities may inform whether to investigate this further. But this, in itself throws up challenges for insurers. In the individual annuity market, we understand that many insurers have changed their normal pricing models for customers approaching them for an annuity – thinking that there is a good chance that the member has already considered a medically underwritten price, not taken it and hence may be relatively healthy. There is a fear of a similar change in the bulk market, pushing up the price of traditional bulk annuities for smaller schemes. There are currently four insurers prepared to quote for bulk annuities using medical underwriting. Just Retirement and Partnership have brought their expertise from the individual enhanced market joining well established bulk annuity providers Aviva and L&G. We expect others looking to make the leap from the individual market, and with more insurers extending their product to quote for deferred as well as pensioner members, this market looks set to be as competitive and flexible as the traditional market.

Collecting medical information The collection of medical information can be a daunting process for trustees to consider – unlike in the individual market, the benefits to members are less tangible. A clear communication strategy is key to help members understand that, not only could this increase the security of their benefits, but also that the collection process need not be lengthy or too intrusive. To date, response rates of 70 – 80% have not been unusual. Trustees will need to consider whether their members will be more receptive to the collection of information by paper form or by telephone. Fortunately, the methods used in the individual market have developed over the years – including those developed by Aon Hewitt’s telephony service which sends data directly to all insurers via a secure portal – and can provide a sound platform for the defined benefit market. The annuity market is always developing and, for once, it appears to be the smaller schemes that should be watching it most closely. Aon Hewitt is launching a unique solution for accessing the new and competitive medical underwriting market in a fast and efficient manner. This service will provide: A one stop shop for collecting medical data and obtaining quotations – this has been designed specifically with members in mind to offer a friendly and hassle free service. Which will result in strong take up rates and ensure that all the necessary data is collected, resulting in the most competitive pricing available A comprehensive market analysis to determine whether the enhanced market terms offer good value A streamlined process for fast and effective execution


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Risk settlement away from the UK While the UK is leading the way in terms of transaction volume (by number, rather than by liability – the US$26bn GM transaction dwarves anything seen in Europe to date) we continue to see growing interest and market activity in a number of other countries. In Ireland, falling bond yields have prevented the anticipated rush to buy ‘Sovereign’ annuities (annuities provided at a lower cost than traditional annuities while introducing an element of credit risk against the Irish Government) although close to €500m of Sovereign transaction was completed, accounting for 75% of the annuity market. These transactions provided welcome additional security for Irish pension funds as well as a welcome influx of capital into the Irish economy. Slightly further afield, a lack of insurance capacity in the Netherlands appears to be one barrier to the completion of risk settlement transactions – along with continued uncertainty (yes, the same uncertainty which has prevailed for four or five years now) over the legislative ability to reduce or curtail benefits. Despite that, we continue to see increasing focus on longevity modelling (we currently have over 50 Dutch pension funds using the Dutch version of our postcode mortality model) and the understanding of longevity risk. In Switzerland, under-estimation of the true impact of increasing life expectancy by pension funds relative to reinsurers, hampers a clear desire by the providers of risk settlement solutions to start to do meaningful business there. We continue to watch this space keenly. In Germany, likewise with significant DB liability, the situation is more complex for a number of reasons, not least as a result of the different structures which in the UK we might class as a pension scheme. Funded plans such as Pensionskassen and Pensionsfonds will typically adopt similar mortality assumptions to insurers (for new plans) or will be required to demonstrate to the supervisor that the assumptions are suitably prudent compared to experience. For these types of plan, risk settlement may become attractive over the longer term. However for now the preference is to retain capital in the business rather than reinsure. Book-reserved, plans (which may be unfunded or funded) will use mortality assumptions which are lower than those used by insurers and coupled with the desire of organisations running these plans to commit cash only when needed to pay benefits, risk settlement markets are unlikely to develop quickly.

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Aon Hewitt

Contact the team John Baines  0121 262 6944  [email protected]

There is better news across the Atlantic where both the US and Canada have proposed updates to their mortality tables and projections. In the US the proposed move to the draft RP-2014 and MP-2014 tables and projections will add around 7% to liability values and bring these valuations much closer to a true picture. In the US market, lump sum options are mainstream (whereby members cash out their pension benefit). As the IRS has already mandated the old tables for 2014 and 2015 funding and lump sum calculations, a short term opportunity exists for companies to offload liability to members at potentially cheaper than market rates. In Canada, new mortality tables are proposed based, for the first time, on Canadian specific data (historically Canadians have adopted US projection scales). This corresponds to an increase in interest in longevity modelling which we have responded to through the development of our own Canadian postcode model. Risk settlement transactions are becoming more common, with the highlight of 2013 a yet to be disclosed company completing a CA$500m buy-in transaction. Like the Netherlands, a lack of competitive environment is becoming an issue although we understand a number of new market participants are starting to beat down doors.

Hannah Cook  020 7086 8115  [email protected]

 [email protected]

Matt Wilmington  020 7086 9358  [email protected]


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