Longevity Risk


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In the last couple of years a number of counterparties, including insurers, reinsurers and investment banks, have come to the market looking to take on longevity risk from pension schemes. A range of different offerings is available, for example insured or capital market transactions, and transactions based on scheme experience or on a population mortality index. Other options include tying in a longevity swap with an LDI strategy to replicate a buy-in.

A handful of deals have been done to date, but there is expectation that the longevity risk transfer market could take off in the next few years. However, capacity may be restricted by a limitation on the ability of direct counterparties and the reinsurers sitting behind them to take on longevity risk if a significant proportion of the c.£1.5 trillion of UK private sector defined benefit liabilities wish to de-risk in this way in the short to medium term.

The benefits of a longevity swap will include:

  • removal of longevity risk, while retaining investment flexibility
  • obtaining protection at a level close to funding basis
  • zero / limited need for upfront cash payment
  • potential early mover advantage
  • lock in longevity element for a future buyout
  • combining cash flow matching to replicate a bulk annuity, but possibly at a lower cost.

A longevity swap or longevity insurance will involve payment of a premium above "best estimate" longevity (although not necessarily above funding assumptions) and also introduces counterparty risk. Therefore, the decision to proceed will need to take account of the risk-return trade off of entering into a longevity swap vs. other risk management options. Consideration will also need to be given to the security of the contract (which will depend on the chosen counterparty, regulatory framework and collateral provisions) as well as a number of other detailed implementation issues.

Mercer has been involved in around half of the longevity swap transactions completed by the end of Q3 2013 as well as four of the five largest pension buyouts completed in the UK to date.

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