Aegon's longevity breakthrough

Insurance-based solutions for longevity hedging have been the norm since the market kicked off in 2009, but limited capacity has resulted in lumpy deal flow. That could all change if the latest deal – a €12bn hedge for Dutch insurer Aegon – is anything to go by.

Not only is it the largest such deal to date, it also represents the only sizeable transaction to see the risk distributed through the capital markets, where bankers believe capacity is enough to absorb huge volumes of follow-on deals.

Under the terms of the transaction, Aegon has purchased longevity protection on just over a third of its €30bn annuity book from lead manager Deutsche Bank. The bank is required to pay a premium if life expectancy exceeds a certain level, and that risk was then distributed to an array of investors through the capital markets using a combination of swaps and notes.

“These liabilities are many years in duration. The key to this transaction is that we found a way to offer very long-dated protection and distribute that risk in a product that has a maturity of just 20 years,” said Michael Amori, co-head of the longevity derivatives group at Deutsche.

“Investors view longevity as an uncorrelated asset. What stopped them buying the asset class in the past was the very long-dated nature of the liability, but what we have created is a structure more in line with long-dated bonds.”

Hedge funds are the likely buyers of such transactions, with some managers including Centurion, Traymar and Tranen Capital establishing specialist longevity funds in recent years.

The structure includes a commutation mechanism that ensures the company continues to be protected for the full duration of the liabilities, following maturity of the swaps and notes.

Despite its large headline size, the notional risk of the transaction is significantly smaller. Although Deutsche declined to confirm the exact figure, a 2009 transaction for Aviva covering £475m of liabilities had notional risk of just £50m.

Capacity problem

Capital markets solutions have long been touted as the answer to the capacity problem stemming from more traditional insurance-backed deals, although the latter are unlikely to disappear altogether.

One benefit of bilateral insurance solutions such as the £3bn deals agreed for Rolls-Royce and BMW with Deutsche’s life insurance arm Abbey Life, (see “Rolls-Royce lands longevity swap”, IFR 1912), and “Live long and hedge”, IFR 1822) is the ability for a more accurate hedge. But bankers involved in this deal believe the company has achieved a strong hedge despite the apparent duration mismatch.

“Given that this is a highly structured trade it was tailored to match the client’s book of business and represents very effective protection. Over 20 years, you will get a very clear answer about what the longevity trend will be going forward,” said Clare Hennings, head of structured insurance solutions at Deutsche.

Capital markets-based solutions carry additional benefits, particularly for insurers looking for a hedge on annuities.

“For an insurance company, being able to hedge a liability without disclosing its book has huge benefits. It was also able to hedge below its cost of capital so was very effective from an economic point of view,” said Hennings.

“As long as the data are out there, companies can complete similar transactions”

Until now, the longevity hedging has been dominated by UK companies and Aegon represents the first Dutch entity to access the market. The transaction also represents the first to be priced using population data from Continental Europe. The pipeline is growing rapidly and bankers expect to see deals from a range of jurisdictions

“The size of life-related risks compared with the property and casualty market is roughly comparable in size, yet life-related capital markets trades are much smaller. There is huge potential for further transactions and the pipeline is not specific to the UK and Holland. As long as the data are out there, companies can complete similar transactions,” said Amori.

Total longevity hedging volume now covers £9bn of UK pension scheme liabilities, according to pensions consulting firm Hymans Robertson.

“2012 will be as buoyant as 2011 for the pensions risk transfer market as pension schemes continue to engage in buy-ins and longevity swaps,” said James Mullins, partner and head of buy-out solutions at Hymans Robertson.

“Providers will continue to ramp up their efforts to meet this demand, which is likely to see insurance companies and banks take on up to £50bn of pension scheme liabilities before the end of 2012,” he added.