PROJECT M
 
PROJECT M
Jim Keane
Matthew Trueblood

Taking the long view

While Akzo Nobel’s longevity swap successfully removed pension liabilities of €1.75 billion ($2.42 billion), the devil is in the details

© Plainpicture

Taking the long view

While Akzo Nobel’s longevity swap successfully removed pension liabilities of €1.75 billion ($2.42 billion), the devil is in the details

The Deal

Akzo Nobel initiated the transaction of $2.42 billion of its liabilities to help protect one of its UK pension funds against the risk of its members living longer than the fund’s calculations. Reinsurer Swiss Re completed the deal in 2012, which related to 17,000 pensioners, through its UK insurance subsidiary.


The Netherlands-based paint and chemicals group initiated the transaction to help protect one of its UK pension funds against the risk of its members living longer than the fund’s calculations. Reinsurer Swiss Re completed the transaction, which related to 17,000 pensioners in 2012, through its UK insurance subsidiary.

PROJECT M

Jim, Matthew – Akzo Nobel opted for a swap to hedge longevity risk. What attracted you to this particular solution as opposed to others?

Jim Keane

At Akzo Nobel, we have very significant pension liabilities and our policy is to try and de-risk those over time. We’ve done significant work in the area of interest rates, inflation hedging and so forth. A major risk that needs to be addressed is longevity: like everyone else, we’ve experienced ever-increasing liabilities due to rising life expectancy.

In an ideal world, you would hedge your inflation and interest rate risks first as they tend to be the most volatile. After that, longevity risk would be next on the agenda to achieve a solution similar to an in-house annuity, where you’re not picking up all of the reserving profit lines associated with a full-blown annuity policy, at least whilst the risk remains on the balance sheet. Basically, however, we saw an opportunity to hedge some of our longevity risk for an attractive price and we went for it.
The provider, Swiss Re, had a UK-regulated insurance company, so we received the risk pricing directly from the end carrier instead of having an investment bank intermediate the transaction. The banks, on the other hand, relied on prices they obtained on the reinsurance market.

Matthew Trueblood

At the time, the pricing for this type of deal looked attractive relative to our liabilities. In fact, it was sufficiently close to our estimated liabilities that no additional upfront cash funding was required from Akzo Nobel, which was appealing to the company. We had a well-funded scheme, which carried out the swap.

PROJECT M

Did you consider other ways of hedging longevity risk? Are you looking at alternative hedging solutions for now or the future?

Jim Keane

Yes, we looked at other solutions, such as bulk buy-ins and buy-outs, but they seemed very expensive at that time. For that sort of transaction, there would always be a premium because you’re paying for the insurers’ reserving requirements, capital requirements and profit. There’s always going to be a significant cost over and above whatever provisions we currently make. But we’re always looking – who knows?

PROJECT M

What do you consider to be the highlights of the deal? And what could have been improved?

Jim Keane

It was good to be able to deal with the ultimate risk carrier directly. The advisory support throughout the tendering process also went well. Some of the contractual details were challenging, however. We were conscious that we were negotiating a contract with a potential duration of 60 years and in retrospect, perhaps we over-engineered some of the contractual terms. It took about nine months to complete the transaction.

Matthew Trueblood

We exchange and value data covered by the deal on a quarterly basis, and I am already at the point where I wish we hadn’t written certain things the way we had, as they are onerous to manage.

PROJECT M

Looking back, what would you do differently?

Matthew Trueblood

If we did another swap or anything similar, like a bulk buy-out, we would run it much as we would an M&A transaction, keeping competitive tension for as long as possible with hard deadlines for completion. At times, in this transaction we found it difficult to get the key parties with appropriate authority into a room to negotiate with us. It is essential to get all parties to commit to the negotiations and agreed deadlines.

Jim Keane

It’s more the details we would change. On a high-level view, we have no question about whether longevity was a good thing to hedge. And the deal is doing what it is meant to. We weren’t approaching this as a way to make a profit but were simply seeking to hedge a relatively unknown risk. If longevity improves dramatically, it provides great protection.

On the flip side, we think it would take quite some time for any reverse in longevity to work its way through and give us any benefit. In our view, the downside protection is more valuable than any potential upside we are giving up by insuring it. Relative to our liabilities, we found the terms attractive, and we still think so despite some of the detailed headaches that go with it. It’s quite a small market, so pure longevity hedges are quite rare.

PROJECT M

Why do you think the market is so small? What are the limiting factors?

Jim Keane

There are several reasons. Firstly, longevity swap transactions are difficult and complex. Secondly, there aren’t many players in the market. Then there’s the big question, which we’ve been asked several times: is it a good deal and is it good value? You don’t sound very professional when you say, “Yes, it probably is, but we can’t really point to anything for certain as it’s too early to tell.”

Life expectancy increases slowly, so only time will tell. You also have to put it into the context of how exposed you are to pension risks, how important it is to hedge them and what proportion of the liabilities you’re hedging. We have very significant liabilities, and this is only one portion of that.

PROJECT M

How do you see the market developing?

Matthew Trueblood

As far as we’re aware, there is no direct carrier of the risk out there looking for business in the UK; it’s all intermediated via insurers or banks. We considered the bank-facilitated agreements, where liabilities were capped and the length of coverage was limited, but this is against what a company naturally wants to do. If a company is going to pay a premium to get a risk off the table, it wants it completely off and not coming back when things turn bad, or after a number of years. That might be a barrier to the capital markets coming in because they don’t want to hold this sort of risk indefinitely and with no caps on it.

I think that’s a reason why we haven’t seen more players coming in at this stage. In addition, large insurers on balance probably prefer deals that involve the transfer of assets, such as bulk annuity deals rather than pure longevity deals.

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