Pensions risk transfer: longevity transactions hedging risk trustee considerations

Consideration of the questions can help trustees regardless of which of the structured options they select for the transaction. Those options are:

• the traditional intermediated structure, where the trustee contractual relationship is with the insurer and not the reinsurer;
• the disintermediated structure involving on-shore or off­shore insurers either within the same group as the trustee or third-party insurers or third-party insurers, otherwise known as the "pass-through structure", where broadly the trustee may take the credit risk of the reinsurer and not the insurer — and vice versa; and other contractual commitments may be given directly between the trustee and reinsurer; and
• the enhanced pass-through structure which is, broadly, a combination of the intermediated and disintermediated structures.

Read more on pensions risk transfer

• Pensions risk transfer: achieving data protection compliance
• Pensions risk transfer: requested contractual terms
• Pensions risk transfer: trustees’ rights to use scheme assets
• Pensions risk transfer: getting governance right
• Pensions risk transfer: the value of a clear vision for full scheme buy-outs
• Pensions risk transfer: reinsurer requirements
• Pensions risk transfer: company wind-up indemnities
• Pensions risk transfer: the risks of residual risk insurance
• Pensions risk transfer: PPF+ deals
• Pensions risk transfer: discretionary pension increases
• Pensions risk transfer: GMP equalisation and bulk annuities
• Pensions risk transfer: data warranties
• Pensions risk transfer: material change
• Pensions risk transfer: insurer buy-out requirements
• Pensions risk transfer: the endgame strategy
• Pensions risk transfer: tricky benefits to insure

Which lawyers are advising which parties?

Where the insurer is in the same group as the trustee, will – and, if so, to what extent will – the same lawyers advise both the trustee and insurer? The insurer may well require certain structural and commercial issues to be taken into account and, where these are identified late in the day, they may introduce execution risk when other more commercial terms have already been settled.

Also, lawyers may not be able to advise both the insurer and the trustee late into the transaction where they have already advised one of those parties on a more partisan basis.

Are any third-party providers providing services?

Where a third-party is providing, for example, collateral management, pensions administration or custodian services, are there any specific requirements that that provider requires or limitations as to what it can provide which may need to be taken into account?

Trustees may also wish to consider the gap between any limitations of liability imposed by a service provider and those agreed under the transaction documents themselves.

Any third-party service providers should be identified and engaged as early as practicable in the transaction timeline.

Does the transaction cover different sections of a scheme?

If so, the trustee will need to ensure that the liabilities relating to each section are met out of the relevant section of the scheme and that there is no contagion risk. Where we have seen sectionalised schemes insuring longevity risk, separate documentation is typically completed in respect of each section to maintain legal separation of the contractual arrangements.

Structurally, each set of transaction documents can be independent. Commercially, however, it may have been agreed that components be aggregated so that they operate economically as a single transaction. This will need to be considered upfront at the structuring stage. An example is where a single pricing basis and fee has been applied to each section irrespective of the extent to which the underlying experience differs. 

Does the trustee require future flexibility?

A hot topic is the extent to which the trustee is keen to have the flexibility to efficiently convert the longevity insurance to a bulk annuity policy and, therefore, the longevity reinsurance to a reinsurance of a bulk annuity policy rather than a reinsurance of a longevity insurance policy.

This may also impact which intermediary the trustee chooses to transact with for longevity insurance purposes and which reinsurer the trustee chooses to transact with.

From experience, trustees and reinsurers are generally commercially aligned but may be diametrically opposed to what they are willing to commit to contractually. A trustee may wish to commit a reinsurer to reinsure a bulk annuity policy regardless of, for example, whether it is the insured population. Reinsurers may wish to ensure that they are, for example, happy with the identity of the insurer and other factors before they are willing to so commit. There is a risk that the trustee requests broad rights for future flexibility which the reinsurer is only willing to accept subject to strict and tight parameters which may effectively neutralise much of the flexibility.

Trustees may wish to identify what type of flexibility is likely to be practically most relevant and then gauge with the various reinsurers what contractual comfort they are willing to provide that they will continue to reinsure on that basis.

Other than price, what are the other material commercial terms?

We have seen that different reinsurers are willing to accept materially different commercial terms which may create value for a trustee or insurer. This can range from amounts payable on termination and any data error remedy, to more administrative matters such as lengths of time after which suspended beneficiaries are treated as deceased, to requiring full payroll information. Trustees should identify what other terms are important upfront to ensure that these are on the negotiating table.

What data protection issues need to be considered?

Data may be shared for pricing purposes and therefore all relevant data protection matters may need to be considered at an early stage. This would be relevant not just for the reinsurers but also for any off-shore captive insurer. Even if data is anonymised, it does not mean that there are no data protection issues. This is because of the possibility of re-identification.

What other issues arise due to the structure being proposed?

Each of the three different structure options present different legal and commercial structuring issues which trustees would find useful to identify and resolve upfront.

Advisers can help

Get lawyers involved early. We see lawyers and consultants as being opposite sides of the same coin, both of whom can bring knowledge and experience to the table when considering the structure of deals and the alternatives available, overall commercial terms and process, which can help to reduce execution risk.