Aegon awarded ‘Institutional Deal of the Year’ and establishes a market for longevity risk
Aegon's award-winning transaction involved longevity risk ˗̵ the risk that beneficiaries outlive their life expectancies, thereby forcing pension funds to pay out more benefits than they had planned for.
The transaction, which took place in December 2013, followed a EUR 12 billion deal with Deutsche Bank and investors in 2012. Distributed to investors by Societe Generale, it hedged the longevity risk of EUR 1.4 billion of Dutch annuity obligations (longevity) and USD 5.0 billion of US-based mortality (US life policies).
It worked by effectively creating a put option on the risk. This means that if Aegon's risk moves adversely, it can collect up to EUR 200 million of the capital pledged by investors when the deal matures after 20 years.
Attractive deal
The transaction was structured to be attractive to investors, bring capital relief to Aegon and, in turn, help pension funds meet their obligations to individuals who are living longer than ever.
Hedging risk is not unusual. Insurers regularly work with banks and reinsurers to hedge their exposure. Aegon's approach is noteworthy by the fact that it was able to attract new sources of capital in large amounts at an attractive price – something that wasn't previously possible.
What made the deal unique?
Transactions had previously been structured in the form of 50 to 60-year swaps between two parties. "We found a way to wrap the obligation in a 15 to 20-year transaction," explains Chris Madsen, Managing Director of Aegon's internal reinsurer Aegon Blue Square Re.
"This allowed us to reach capital market investors who prefer to invest for 15 years or shorter. This is a much larger group of investors beyond the usual reinsurers, including hedge funds, sovereign wealth funds and other asset managers."
Transparent and scalable
The approach offers complete transparency, which is valuable to Aegon and to investors. Aegon has an internal model that was used to value and structure the deal, but to help investors, modelling firm Risk Management Solutions (RMS) was brought in to create a model that could be shared with potential investors.
"Not only did this give people confidence in terms of the value proposition - everybody knew down to the penny how much we were making - but it also means everyone is looking at the same model for the mark-to-model," says Jeff Mulholland, head of insurance and pensions solutions Americas at Societe Generale.
Innovative approach
"The market hadn't seen a transaction like this before," says Chris Madsen. "More buyers, meant Aegon was able to execute at a better price and the reinsurers and investors that might have been shut out from a two-party transaction gained access to a valuable source of diversification. Capital markets investors will also appreciate that longevity risk is completely uncorrelated with market risk. We've paved the way to creating a deeper market in longevity risk and that is what the market is recognizing with this award."
