Ever increasing life expectancy means increased longevity risk for pension schemes and their trustees. Historically, pension scheme trustees have had few options to address this risk which is now often the single biggest risk that trustees and the scheme sponsors face. Following on from insurance buy-in or buy-out or hedging solutions, more recently a market has developed for hedging longevity risk through the global reinsurance market.
The use of Guernsey incorporated cell companies (ICCs) and incorporated cells (ICs) has proven to be an innovative and efficient solution for trustees wishing to access the global reinsurance market for purposes of hedging longevity risk by establishing their own captive insurer in Guernsey.
HOW IT WORKS
An ICC is incorporated in Guernsey with the consent of the Guernsey Financial Services Commission (Commission).
Following the incorporation of the ICC, an IC is incorporated. The trustees of the pension scheme subscribe for all the cell shares in the IC thereby establishing the captive insurer.
The IC enters into the longevity insurance agreement with the trustees of the pension scheme and a back to back longevity reinsurance agreement with the reinsurer. The IC’s liabilities under the insurance agreement are fully hedged by the reinsurance agreement.
The IC is a separate legal entity with limited liability for the cell shareholders. The IC’s assets and liabilities are separated from those of the ICC and any other ICs. The IC’s liability to the trustees of the pension scheme and the reinsurer is limited to the assets of the IC and recourse cannot be had to the assets of the ICC or any other incorporated cell.
Collateral arrangements can be put in place in order to underpin the risks and exposure of the trustees on the one hand and the reinsurer on the other.
The IC is required to be licensed under the Insurance Business (Bailiwick of Guernsey) Law, 2002 (Insurance Law) and to comply with certain minimum capital requirements and minimum solvency margins prescribed by the Insurance Law, subject to modification or waiver by the Commission.
It is a standard condition of long-term insurance business licences that the insurer’s assets representing at least 90% of policyholder liabilities is required to be held in trust in Guernsey. However, if the liabilities are fully funded by reinsurance, the Commission may be prepared to disapply this standard condition.
The ICC/IC structure requires a Guernsey based corporate service provider, and insurance manager, actuary and other usual professionals. It is important to ensure that the structure is set up and operated from Guernsey in a manner which ensures that the IC is based offshore.
The cost of establishing and running the ICC/IC structure for a relatively large transaction are likely to be significantly less than the costs a pension scheme would otherwise have to pay using an intermediary insurer. The structure allows much larger single transactions to be put in place with single reinsurers resulting in less complex arrangements and better pricing.
TRANSACTIONS TO DATE
In 2014, the BT Pension Scheme (BT) set up the first ICC/IC in Guernsey to undertake a £16 billion longevity swap between an IC set up specifically for BT. Carey Olsen acted as Guernsey counsel to the BT trustees.
Carey Olsen has recently acted for the Merchant Navy Officers Pension Fund’s trustees in connection with setting up an IC for the purposes of entering into a £1.5 billion longevity swap transaction.
The use of a Guernsey ICC and IC as captive insurer is an innovative solution which can help pension schemes manage longevity risks using a structure tailored to their specific needs.
Setting up a standalone structure like BT did would be an attractive option to larger pension schemes.
However, smaller pension schemes also have the opportunity to use such a structure with various providers establishing ICCs in Guernsey where separate ICs can be acquired and established for various scheme’s trustees to undertake longevity swap transactions.