By Cecilia Valente and Joel Dimmock
Investment banks, muscling their way in to the market for hedging pension risks, are on course for marriages of convenience with specialist buyout firms as they seek to make money from Europe's ageing population.
Credit Suisse last week underwrote Britain's first-ever longevity swap, taking on the risk that pensioners from engineering company Babcock exceed their expected lifespan.
The fledgling longevity swap market, which uses securitisation tools common in investment banking, has developed alongside a financial crisis that has forced the traditional buyout pensions specialists to reassess risk.
In the long term, longevity swaps pose little threat to the buyout model, though they are likely to have a lasting impact on the way pension funds are managed.
"UK pension schemes are now moving towards full buyouts. It will be over decades, but the majority are now thinking they need to get rid of their schemes once and for all," said Jerome Melcer, partner at consultant Lane Clark & Peacock.
Privately-backed buyout companies such as PIC, Paternoster and Pensions First took some 8 billion pounds of pensions on to their balance sheet in Britain last year.
But the firms — which transfer all pension assets and liabilities on to their own books — have been hit by the credit crisis as soaring yields have forced them to reassess risk, increasing costs for client companies.
The buyout market remains till in decline, with deal value falling 50 percent for defined benefit schemes during the first quarter, figures from Aon Consulting showed.
JOINING FORCES
The downturn has attracted banks to offer alternatives such as longevity swaps which, as they stagger payments over the course of the deal — in Babcock's case 20 years –, are more affordable than full buyouts, which charge a one-off premium.
Next to Credit Suisse, JPMorgan is also jostling for a position, as is Swiss RE, a reinsurer with substantial expertise in capital markets.
But industry insiders regard such nifty new tools as interim solutions. The trend towards full buyouts is set in stone, they say, and pension buyout firms will either set up longevity swaps themselves or set up ventures with banks.
"Look out for the buyout firms either doing this on their own or in conjunction with an investment bank. I think you might see partnerships developing," said one senior industry player who requested anonymity.
Talks were already taking place on this basis, the source said, as more companies sought bids for alternative ways to address the potential burden of longer lifespans.
"If you saw one or two buyout firms with one or two investment banks you might conclude that's a stronger offering than a traditional insurer on its own or a traditional investment bank," he said.
Ventures between banks and buyout firms would give clients access to potential buyout providers at the same time as they agreed a longevity swap deal.
"There seem to be trends in pensions, a bit like clothes," said Tiziana Perrella, head of buyouts at consultant PCS. "We have had buyouts and buyins, and now it may well be the year of the longevity swap."
Pension trustees may prefer to hedge longevity risk with buyout specialists to prepare for a full buyout later on, she said.
The senior industry source said buyout firms could appeal to clients by agreeing to conduct a future buyout using the same mortality assumptions as used for a longevity swap, making life easier for the client and securing a stable price.
John Fitzpatrick, a partner at PIC, said his firm had a pipeline of longevity deals of 20 billion pounds to compensate for the drop in its traditional business.
"Trustees will prefer an insurance policy from an FSA-regulated insurer. They will prefer a level of conservatism to protect them," he said.
Credit Suisse declined to comment on its strategy. Swiss Re said it was conducting "a great many discussions with parties interested in longevity risk transfer. JP Morgan closed two longevity swap deals last year.
Paternoster, which bid on the Babcock deal, is preparing to offer longevity swaps in half a dozen bidding processes it is currently involved in, the group's CEO Mark Wood told Reuters.
Legal and General (L&G), a dominant player in the British buy-out market, has yet to get a clear picture.
"A number of important issues need to be resolved if these products are to become viable stepping stones or alternatives to buyout," an official said.
