In fact, longevity is the largest remaining risk facing DB schemes once they have significantly reduced their investment risk.
Longevity risk can be complex and concentrated. For example, your wealthiest members are likely to account for a disproportionate share of DB pension liabilities — and these members are likely to live longer than the scheme average, compounding the risk to your scheme’s funding.
DB schemes reaching their endgame can remove longevity risk through bulk annuity transfers. For the many DB schemes that aren’t in this position, longevity swaps are an increasingly popular risk-transfer option.
Here is how a longevity swap works:
- A longevity swap transfers the risk of members living longer than expected to an insurer.
- The scheme’s trustees agree to make fixed payments to the counterparty based on the expected payable benefits — plus a fee.
- In return, the insurer takes on the pension liabilities by agreeing to pay whatever benefits are due over time.
The longevity swap market is developing to support more DB schemes
Longevity swaps can be a stepping stone on your DB scheme’s path to its endgame if you have already significantly reduced investment risk and have a long-term ambition to de-risk.
In July 2022 Mercer advised the trustee of UBS’s DB scheme on a £0.5 billion extension to its longevity hedge. The transaction means that £1.9 billion, or about two-thirds, of the scheme’s DB pension liabilities are covered by longevity swaps.
In a market first, the longevity swap covers the scheme’s deferred members aged over 60 as well as the pension liabilities of the unhedged DB current pensioners.
As the UBS transaction demonstrates, the market for longevity swaps is developing all the time to meet the requirements and characteristics of DB schemes.
About £15 billion of longevity swaps were transacted in 2021 comprising four deals. This was the third-highest year on record and we expect interest in this risk-transfer option to remain strong as the market evolves to support more schemes.
In this video, Mercer’s Suthan Rajagopalan talks about which DB schemes might consider a longevity swap and whether deferred pensioners can be included in such a transaction.
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