Longevity swaps

Updated July 2009

The trustees of the Devonport Royal Dockyard pension scheme have recently concluded the first longevity swap between a pension scheme and a counterparty (in this instance Credit Suisse). Other pension schemes may be expected to follow suit.

In common with other forms of swap, a longevity swap aims to eliminate volatility by allowing pension schemes to swap an uncertain liability for a certain one. The trustees make regular payments to the bank or insurer counterparty based on agreed mortality assumptions. In return, the counterparty makes payments to the trustees based on the scheme’s actual mortality rates.

Longevity swaps are the latest in a long line of increasingly innovative ways of reducing pension scheme risk, continuing in the tradition of inflation and interest swaps, bulk annuities and buy-outs. They are potentially attractive to schemes because they allow trustees to control the longevity risk without going to the lengths of a full buy-out, possibly at a time when the buyout price might not be favourable. It would also seem that there is a healthy appetite in the market to assume longevity risk.

There are a number of issues that trustees and employers must face before they go down this road. First and foremost they will need a close analysis of their scheme's longevity profile. Then price, counterparty strength, the need for (and terms of) collateral arrangements, and the need to monitor effectiveness are only some of the other things that need to be considered. The parties will need significant input from their actuarial advisers from the outset, but once they have decided to proceed in principle, they will also need to involve their lawyers in the detail.

TLT’s Pension Investment team combines the skills and experience of pensions, capital markets and banking lawyers to give clients pro-active, responsive and clear advice about the legal issues involved in pension fund investment. We have acted over the years for a number of local authority and private pension funds on investment matters.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at July 2009. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.