Longevity risk transfer: a bank swap against reinsurance

Structural difference

Option A is a derivative: it settles the difference between agreed fixed payments and actual pension payments. It transfers the longevity risk financially but not the legal obligation, and it is a bilateral contract with a bank. Option B is insurance: the liability itself is shared, it sits within the insurance regulatory framework, and it comes with trust collateral and standard reinsurance protections.

Capital

• Reinsurance reduces the longevity sub-risk in the SCR for the transferred share, with the counterparty default risk module picking up the A- reinsurer and the trust collateral reducing that charge. The risk margin should fall materially - a £400m risk margin on a longevity-heavy book is a large prize, because the reference undertaking's SCR is lower.
• Swap: a derivative may be recognised as a risk mitigation technique, but full SCR credit requires demonstrable effectiveness and the PRA is likely to challenge it. Expect a smaller capital benefit than straightforward reinsurance, and possibly a capital add-on. This must be tested with the PRA before signing, not after.

Matching adjustment - the decisive issue

• Reinsurance is an eligible risk mitigation arrangement. The retained and reinsured cash flows must be treated consistently and the MA recalculated on the retained business.
• A derivative swap with a bank is generally not reinsurance, so the liability cash flows used in the MA calculation are unchanged. The swap sits outside the matching portfolio - but the collateral does not. Every pound posted as collateral is a pound that may have to leave the MA portfolio or be replaced, reducing spread income and potentially the 132bps benefit on £3.4bn. Get written clarity on this interaction before signing.

Counterparty and liquidity

• Bank: two-way collateral, weekly recalculation, three-day call. The termination right on a two-notch downgrade of Ashby is the most dangerous term in either document - it can end the hedge at exactly the moment Ashby is under stress.
• Reinsurer: 30-day settlement and trust collateral is slower and less responsive to mark-to-market, leaving more unsecured exposure to an A- name, but it creates no daily liquidity demand.

Conclusion. On capital, MA certainty and liquidity, the reinsurance is cleaner and probably more valuable than its headline cost suggests. The swap is more precise and likely cheaper on price, but it shifts risk into the collateral and MA machinery, which is where a life insurer is least able to absorb a shock.

Size the exposure

• The £1bn slice has a duration of 14 years. The net mark-to-market of a longevity swap moves with realised mortality against expectation and with real interest rates.
• A plausible stress - real yields down 1%, or improvement running 1% a year faster than assumed - could move the position by 10–15% of the protected value, i.e. £100m–£150m. A one-in-twenty weekly move might call £30m–£50m; a genuine mortality shock or a rate rally could call considerably more.
• Against that, £260m of liquid unencumbered assets for a £3.8bn book is thin, and not all of it is available: some must support the MA portfolio, ordinary liquidity and day-to-day operations.

Can Ashby support it?

Not comfortably at the current level. A £50m call absorbs about a fifth of the liquid pool, 105% collateralisation leaves no buffer, and two calls in a month would force asset sales - possibly at a discount and possibly out of the MA portfolio, which is a double hit. The downgrade termination right compounds it: it is a contingent liquidity event that is correlated with the stress that triggers the collateral calls.

Mitigants to negotiate

1. A collateral threshold, for example the first £25m uncollateralised, so ordinary market noise does not generate cash calls.
2. A longer call period - five business days rather than three - and a documented dispute process.
3. Eligible collateral widened to include high-quality government bonds already held, so posting does not force sales, with written confirmation from the PRA that posted collateral does not breach the MA conditions.
4. Downgrade protection for Ashby: a cure period rather than immediate termination, and a right for Ashby to substitute an acceptable replacement counterparty or guarantor.
5. A dedicated liquidity buffer sized to the stress - a committed facility rather than relying on the £260m - and a cap on the notional of any single swap.
6. Split the £1bn across two counterparties to avoid single-name concentration and to preserve negotiating leverage.

Recommendation. Proceed with Option A only if the threshold, the longer call period and the cure period are agreed. If the bank will not move on the termination right, use the reinsurance for this tranche and revisit the swap once the liquidity buffer is genuinely in place. The transaction should be approved on the stress case, not the base case - and the board should be shown the stress case in the paper.