Longevity Hedging Demystified: 12 Key Facts for Trustees | Insight Investment

Defined benefit pension schemes face significant longevity risk as life expectancy trends remain uncertain. Longevity hedging, including targeted swaps, can reduce exposure while preserving flexibility for buy-out or run-on endgames.

• Longevity risk remains the largest unhedged exposure for many defined benefit schemes approaching endgame objectives.
• Life expectancy may not continue falling; medicines, policy and potential life extension could increase longevity.
• Longevity swaps can hedge specific populations, including deferred members, enabling tailored coverage beyond pensioners too.
• Market capacity is deep across reinsurers, while pricing is at historic lows and required return uplifts small.
• Hedges accept diverse collateral and maintain future flexibility, aligning with buy-out pathways and run-on strategies.

The case for longevity hedging

UK life expectancy at 65 has fallen in recent years, yet future improvements remain possible. For most defined benefit pension schemes, longevity is the largest unhedged risk, and transaction volumes have surpassed £120bn in recent years. This combination of uncertainty and material exposure underpins demand for practical longevity hedging solutions.

How longevity swaps work

A longevity swap exchanges fixed, inflation-linked payments for floating payments linked to actual pensions due to members. Transactions are typically intermediated by an insurer, aligning hedge cashflows with scheme benefit payments. Pre-agreed cashflows enhance certainty relative to fluctuating benefit payments.

Design and scope of longevity hedges

Hedges can target specific member cohorts and extend to deferred members as well as pensioners. Publicly disclosed transactions illustrate flexible structures, including captive arrangements and sponsor-led solutions, to match scheme demographics and objectives. Targeting improves hedge efficiency and aligns costs with priority liabilities.

Market depth and pricing

Multiple well-regarded reinsurers compete to assume longevity risk, supported by strong long-term financial strength ratings. Indicative pricing has fallen to historic lows amid greater competition and higher interest rates, reducing the additional return required from scheme assets. Smaller required uplifts support practical funding plans.

Figure 1: Longevity hedge pricing has fallen to historic lows in recent years

Collateral and endgame flexibility

Longevity swaps can be collateralised with a wide range of eligible assets, including cash, gilts, supranational and agency debt, and corporate bonds. Hedges can align with buy-out pathways or support run-on strategies, preserving flexibility as schemes progress toward endgame. Eligible collateral lists should be agreed within governance and treasury constraints.

Conclusion

Longevity hedging offers targeted risk reduction with market depth, competitive pricing and flexible implementation. Trustees can evaluate swaps that match scheme demographics, collateral preferences and endgame plans, helping defined benefit pension schemes manage uncertainty around future life expectancy and benefit cashflows.