Swiss Re Insurance-Linked Fund Management

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Longevity swap may only remove as little as 30% of a scheme’s longevity risk


Punter Southall, a UK based actuarial and investment consultant to many large UK pension schemes, has published a press release commenting on the recent ITV longevity swap transaction warning pension schemes of the sometimes limited nature of the risk transfer a longevity swap provides.

The £1.7 billion ITV longevity swap has received significant attention in the press, but Punter Southall warn that the full story is not being told.

Adam Gillespie, head of buyout and longevity research at Punter Southall, said;

“Longevity swaps like the deal recently entered into by the ITV pension scheme can offer a more cost effective route to risk reduction than the purchase of annuities. However, such deals typically only remove the longevity risk associated with pensioner members.

The scheme remains exposed to the risk of increases in life expectancies for younger members, for whom longevity risk can be more than twice as large as for a pensioner. Experience from our clients show that a longevity swap might only remove as little as 30% of a scheme’s longevity risk.

Other types of longevity products, such as the index hedge used by the Trustees of the Pall (UK) Pension Fund earlier this year, can be an effective way of reducing the longevity risk associated with these younger members. Such products are based on the mortality experience of the wider UK population rather than that of the pension scheme and, importantly, are available to all pension schemes, not just the very large.

Whether such products offer good value for trustees and scheme sponsors depends on their risk budget and vital pre-deal cost-benefit analysis. Our detailed investigations conclude that the cost of entering into a longevity swap is generally too high to be a feasible solution in light of the risk budget of most schemes.

Interest in longevity swaps has been high ever since the Babcock scheme transacted the first deal just over two years ago. However, this initial attraction has not translated into many deals. The recent ITV case is the first longevity swap transaction for over 12 months and the number of deals done to date remains in single figures.

Given the recent market turmoil resulting in a large fall in equity values and bond yields, trustees and sponsors should ensure they have considered all the keys risks faced by their pension scheme, not just that of rising life expectancy. Having a suitable liability hedging strategy in place to manage these risks can be an invaluable way of protecting scheme balance sheets during such volatile economic times.”

No hedging mechanism is 100% effective and they should all be utilised as a piece of an overall risk management and transfer framework. However, the comments leave us wondering whether there are amendments and changes to the structure of longevity swaps which could be made to account for the liabilities associated with future pensioners. We’re interested to hear any comments from people working in the longevity swap sector.

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