National Post (National Edition)
A brief history of longevity risk
Start very big, say in the $5-billion range, move to a transaction that is very small say, in the $35 million range — and along the develop a system that can be applied for everything in between.
That’s the brief history of insuring longevity risk in Canada, a system that allows defined-benefit pension funds, for a fee, to offload their pension payment obligations if the retirees live longer than expected, to an insurance company.
The country’s second transaction — involving 220 retirees and $35 million of payments at Canadian Bank Note Co. — closed recently, about 20 months after Bell Canada opened up the market with a deal involving $5 billion of payments.
Both deals are complicated and long term: over a 40 year-term both funds will pay premiums, on a monthly basis, to the two insurance companies (Canada Life and Sun Life Financial Inc. respectively) while the two insurers will make monthly payments to the two pension funds for the lifetime of the retirees.
The Canadian Bank Note contract calls for the insurer to pay the fund, if pensioners live longer than anticipated, with the $35 million being the present value of the future payment streams it expects to make to its retirees. In the situation where the pensioners die sooner than expected, the fund will pay the insurer. In reality, for what is akin to a swap arrangement, there is a small annual difference in the monthly flows of payments.
While both transactions were designed to achieve the same purpose — to de-risk the fund — the two shared a common consultant, Mercer Canada.
Manuel Monteiro, group leader, at Mercer’s Canadian financial strategy group, said the firm “found a way to streamline the (process) and has created a viable solution for pension plans of all sizes. Previously (before the deal for Canadian Bank Note transaction) it was thought that you needed billions of dollars for this to be viable.” The pension fund at Canadian Bank Note is home to less than $100 million of assets — about one per cent of the assets held in Bell Canada’s defined-benefit pension fund plan.
“That was the challenge (with the latest transaction), finding a way to do this in a streamlined way,” and at a “price point that made sense for a client like Canadian Bank Note,” said Monteiro, adding that on a normal transaction the advisory fees would be “very expensive.”
Given that Mercer’s employees didn’t work for less, how did it ensure that the fees for the pension fund weren’t too high?
While Monteiro didn’t want to delve too deeply into the “details of what we did,” on the grounds that it was proprietary, he said the complexity of insuring for longevity risk arises in large part because of “counterparty risk.” That term is defined as to risk, to each party, that the counterparty will not live up to its contractual obligations. “We found a way to do that and measure the value of the deal in a much more streamlined way,” he added.
“What’s exciting is that a solution has been found for pension fund sponsors of all sizes to hedge their longevity risk while continuing to invest the assets in a way that suits their strategy,” added Monteiro.
On Bell’s deal, Sun Life reinsured the longevity risk with two other companies. In that note Bell said it was “normal practice — and simply good governance — for insurance companies to reinsure with other companies in order to hedge their own risks.”
(PREVIOUSLY) NEEDED BILLIONS FOR THIS TO BE VIABLE.