Fitch Ratings says Rolls-Royce’s longevity swap is an important step in managing one of the key risks facing occupational pension schemes. The deal, announced 28 November, is one of a handful of major transactions so far in a market that is expected to grow. It is not expected to affect Rolls-Royce’s ‘A-‘/Stable rating.
Longevity risk represents both a long and short-term risk to pension schemes. The long term effect is obvious – the longer pensioners live the more has to be paid to them. The short term risk arises from the revaluation of pension liabilities as evidence grows that assumptions need to be changed. In the last five years most companies have built in assumptions of longer lifespans into their pension schemes – causing a one-off increase in liabilities. Under the UK’s existing regulatory system such increases lead to higher funding requirements in the short to medium term.
Longevity hedging – contracting with someone else to bear some or all of a scheme’s longevity risk – is not a cheap option. It carries significant administration costs, plus a premium is paid to insurers or other counterparties to take on the risk. This is usually shown as an immediate increase in liabilities. When ITV in August undertook a longevity swap on GBP 1.7bn of its pensions, the result was an increase in liabilities of GBP50m – or about the equivalent of a one-year change in life expectancy.
Rolls-Royce’s pension scheme is well funded, with an accounting deficit of less than 2% of liabilities at 30 June 2011. The longevity deal it has struck with Deutsche Bank will apply to GBP3bn of the group’s approximate GBP7bn UK pension liabilities. The group said that the transaction cost will be borne by the pension fund and ‘will have no material effect on the funding arrangements.’
Fitch’s pension methodology focuses on the cash funding costs to companies of providing pensions. In the UK longevity can affect this in that changes in assumptions often lead to significant increase in deficits which have to be funded. To the extent that a longevity swap eliminates this risk, this is positive for a company’s credit quality. Against this is the cash cost of such a deal.
Source : Fitch Ratings Press Release