The pension risk transfer sector is heating up; according to Risk Transfer Report 2022, from consulting firm Hymans Robertson, the past four years have provided the biggest years yet for buy-in and buy-out volumes in the United Kingdom, the space’s largest market.
Where insurance companies lead, reinsurance companies follow. Consequently, the funded reinsurance market – where insurance companies turn to manage risk they absorb on completion of these pension risk transfer deals – is on a similar tear.
“Demand from the U.K. pension risk transfer market in particular is driving growth in funded reinsurance,” said Rohit Mathur, Head of International Reinsurance Business at Prudential Financial in Newark, NJ. “Insurers are looking for reinsurance partners to meet that demand.”
The reinsurance sector is taking note; Prudential Financial has been active in the space for a few years, and Pacific Life Re launched a new team, Global Funded Solutions, in April 2021, to enter this market, completing its first deal the following month.
The growth in the funded reinsurance sector has attracted the eyeballs of the private equity industry. Apollo, KKR, Centerbridge and Blackstone all have ties to the sector, and according to Douglas Anderson, Founder at Club Vita, the attraction for these firms makes sense.
“There is a multi-level business model here. PE firms can make money on the profit delivered by the funded reinsurance entity, and they can allocate the assets of the reinsurance companies into one of the parent’s pooled funds as a limited partner. They can create and issue private corporate bonds and have their own funds buy them. There is a lot of synergy here.”
All this doesn’t mean that there will be a rush of buyout shops launching reinsurance arms to compete in the space. Deals take a long time to complete, and they are very large and complex; a typical middle-market private equity or credit manager isn’t big enough and doesn’t have the capacity to deploy all of a reinsurance firm’s capital.
A feature of the UK market is that there are only a few insurance companies active in the space; the aforementioned Risk Transfer Report 2022 shows just eight insurance companies involved in either buy-in or buy-out deals in 2021; Aviva, Canada Life, Just, Legal & General, Pension Insurance Corporation, Rothesay, Scottish Widows, and Standard Life. According to Mathur, when these firms elect to use the reinsurance market to transfer some of their newly onboarded longevity risk, there is a natural hedge that reinsurance companies can provide.
“Insurance and reinsurers are natural holders of longevity risks because they have the offset by way of mortality risk; that’s important because there is an in-built safety mechanism on the balance sheet,” he said.
The natural hedge provided by mortality risk helps in the mortality stress testing element of the capital calculations required by regulators. However, reinsurers also get credit for having a massive pool of all sorts of different low or non-correlated risks, so having marine, aviation and catastrophe risks on the books also helps them when it comes to taking on longevity risk. This isn’t always the case with private equity-backed reinsurance, however.
“Because they tend to lack the offset, they have greater risk. If longevity improvements turn out to be higher than they have assumed, they take a profit hit in the future. If they want to pitch the most certain prospective returns to investors, they need to de-risk it by taking out insurance against the most expensive longevity outcomes,” said Anderson.
That said, part of private equity’s pitch is the access to higher yield-generating assets, and the expertise and scale to take advantage of the opportunities that those assets can generate, that isn’t always the case in a pure-play biometric reinsurer. Additionally, it’s almost inevitable that these larger buyout firms will continue to be a player in the space because of capacity constraints in the reinsurance market, particularly in Europe. All this is encouraging for the defined benefit pension funds looking to enter into a pension risk transfer transaction, but Mathur offers a word of caution.
“From the point of view of a defined benefit pension, the more reinsurance companies that are active in the space, the merrier, due to access to different kinds of assets and better pricing from the increased competition. More players supports overall market growth,” he said. “But these are long dated transactions – 30 to 40 years. Insurance companies need to carefully choose a partner that’s going to be there for the long run that has a similar risk management philosophy and alignment.”