Since the first ground breaking deals in 2014, Guernsey has underlined its position as the go-to jurisdiction for longevity risk transfers by pension schemes, now having been home to seven deals in the last five years. Here, Walkers Partner Kate Story discusses the use of the Guernsey ICC for pensions de-risking.
Having advised on this type of deal since the first deals were completed in 2014, from both the sponsor side and the pension trustee's side, in my experience it is the specialist Guernsey structure, the Incorporated Cell Company, combined with the fact that Guernsey is the number one captive domicile in Europe, which is attracting the business to Guernsey.
The longevity problem
The level of longevity risk faced by defined benefit pension schemes has been well documented and has led to pension schemes seeking solutions to manage this risk. Such solutions have included pension buy-outs (for example, the General Motors pension buy-out arrangement with Prudential Financial Inc. in 2012), but in the last several years the trend has been towards longevity swap arrangements.
Typically, in a longevity swap transaction the employer sponsor and/or the trustee of the pension scheme will agree to pay fixed monthly amounts to a financial institution or commercial insurer that in return makes variable monthly payments to the pension trustee. The variable payments are calculated based on the pension amounts that the trustee is obliged to pay to the members of the pension plan. In this way, the risk of members living longer than anticipated (and the liability for pension payments subsequently being more than anticipated) now rests with the financial institution/commercial insurer, which can then enter into a reinsurance arrangement with one or more commercial reinsurers.
However, using insurance intermediaries (commercial insurers and banks) in these risk transfer arrangements became increasingly expensive. In response to this, in 2014 two ground-breaking longevity swap structures were established in Guernsey using a captive insurance company in place of an insurance intermediary, thereby cutting out intermediary fees.
A captive also removes the need for price averaging. Price averaging occurs where intermediaries engage with several reinsurers to spread credit and counterparty risks and exposure limits, which inevitably incurs several levels of fees. Instead of engaging in price averaging it is open to the captive to select a single reinsurer at the best pricing available in the market, although in some of the Guernsey deals more than one reinsurer has been used.
The Guernsey deals to date
The first of the Guernsey transactions was for the BT Pension Scheme, whereby the trustees of the scheme set up their own captive to transact directly with the reinsurance market, in what is believed to be the largest longevity risk transfer transaction to date, in the form of a £16bn longevity swap.
The second was the Willis Towers Watson 'Longevity Direct' structure, which extended this captive solution to Willis Towers Watson's pension scheme clients, with the ability for each pension scheme to utilise a separate risk transfer company under the umbrella of the Longevity Direct service platform.
In 2017, MMC UK Pension Fund Trustee Limited, the pension fund of Marsh & McLennan Companies, completed the longevity hedge of £3.4 billion in liabilities in two transactions – covering around 7,500 pension fund members – using the Guernsey-domiciled ICC, Mercer ICC Limited. Also in 2017, British Airways' Airways Pension Scheme reportedly used its Guernsey captive structure, APS Insurance ICC Limited, to hedge £1.6 billion of liabilities.
Finally, in 2018, Willis Towers Watson completed another two deals under the umbrella of its Longevity Direct product.
Guernsey is recognised as the leading captive domicile in Europe and when compared with competitor jurisdictions has the further advantages (as far as business with the UK is concerned) of having the closest proximity and a special constitutional relationship with the UK. It pioneered the concept of the cell company in 1997 and has always led on innovation in the insurance sector and financial services generally.
The Guernsey Financial Services Commission (GFSC) appreciates industry needs for speed of licensing and flexible, responsive regulation to recognised international standards. Guernsey's insurance legislation is more suited to captive insurance and special purpose insurers than other parts of Europe, given that Guernsey is not subject to Solvency II. Instead, Guernsey has a risk-based solvency regime based on IAIS standards.
On top of these advantages, Guernsey is the only major captive domicile to offer the incorporated cell company. For example, Bermuda 'separate accounts' are not incorporated companies. In 2015 the Cayman Islands introduced the ability to incorporate a portfolio insurance company (PIC) underneath a cell which will take over the insurance business of the cell, but this does not work in the same way as a GICC, and as the PIC must be owned by the Cayman segregated portfolio company on behalf of its cell, the cell owner does not achieve control over the PIC as it does with an incorporated cell of a GICC. Further, Guernsey is on the EU's "white list" for tax transparency and cooperation, which the latter two jurisdictions are not currently.
The Guernsey solution
All of these Guernsey longevity swap deals to date have utilised a Guernsey incorporated cell company (GICC) as the structure to house the risk transfer vehicle, which is an incorporated cell of the GICC. A GICC has incorporated cells which sit underneath the umbrella of the GICC, but are not subsidiaries of the GICC (rather, they are 'associated companies'). The board of directors is the same for the GICC and each of its cells, although there are proposals for this requirement to be changed so that there need only be one common director on the board of the GICC and each cell.
Where a GICC is used as the captive of one business, each incorporated cell can be used for a separate hedging transaction of that business. In the case of a platform, the sponsor of the platform may own the shares in the GICC and each client pension scheme owns the shares in a separate incorporated cell of the GICC, which is used to facilitate the hedging transaction(s) for that client.
An incorporated cell of a GICC can be hived off into a standalone company separate from the GICC structure. So, in the 'rent-a-captive' platform example, a client could convert its incorporated cell into a company independent from the platform. All of the incorporated cell's assets and liabilities would be automatically transferred to the standalone company by operation of law upon completion of the conversion process. Alternatively, an incorporated cell can be transferred to another GICC.
Each of the GICC and its incorporated cells is separately licensed as an insurer in Guernsey under the Insurance Business (Bailiwick of Guernsey) Law, 2002 (the Guernsey Insurance Law) and therefore separately has to meet the capital resources requirements set by the GFSC, although the GFSC maintains a discretion to reduce or waive capital and solvency requirements in appropriate cases, for example where the insurance business is fully hedged or reinsured (as is the case in the usual Guernsey longevity risk transfer deal).
In Guernsey a cell can be established and licensed as an insurer in a matter of weeks rather than months as in onshore jurisdictions.
The GFSC has a discretion to permit a long-term insurer not to appoint an actuary, including where there is a securitisation or reinsurance of longevity-related risks where the risk is unlikely to alter significantly following inception of the structure (again, as is the case for the standard Guernsey longevity risk transfer deal).
How the longevity risk transfer works
Once the GICC has incorporated the incorporated cell and the cell has been licensed as an insurer under the Guernsey Insurance Law (which takes considerably less time than setting up and licensing a standalone company), an insurance contract can then be written between the trustee of the pension scheme and its incorporated cell. At the same time, a reinsurance contract, mirroring the terms of the insurance contract, is entered into between the incorporated cell and the chosen reinsurer, so no risk is retained in the cell. The insurance contract and reinsurance contract need not be governed by Guernsey law.
Because of the advantages the GICC model offers and the successful implementation of the various major schemes to date, with the ability to easily and quickly insure and reinsure longevity risk through a ready-made risk transfer platform, it is considered that there is considerable growth potential in this space, made possible by a Guernsey solution.
For more information about Guernsey's finance industry please visit www.weareguernsey.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.