There are two types of swap currently offered to pension plans: bespoke and index-based.
A bespoke swap transfers all longevity risk (for the members covered) to the provider. The provider agrees to meet the actual pension payments to pension scheme members, regardless of how long they live (the ‘floating leg’ of the swap). In exchange, the pension scheme meets a fixed schedule of payments to the provider, which will not be affected by member longevity (the ‘fixed leg’ of the swap).
While highly effective, bespoke longevity swaps are normally only available for schemes withrelatively large pension populations, as the hedge provider will look for enough member data to price the hedge efficiently. Also, providers will typically offer bespoke hedging for pensioners only, or pensioner-rich plans.
An index-based swap provides protection against future increases in longevity, but only based on the general population and not the specific pension scheme membership. This allows the provider to price a swap, regardless of the size of the pension scheme. Index-based swaps can also be more easily adapted to cover non-pensioners.
Against that, an index-based swap leaves a pension scheme holding an uncertain risk, meaning that movements in pension scheme member longevity are not in line with those of the index population.
Longevity hedging for pension schemes is presently available from a range of providers, primarily investment banks and insurance companies.
Jerome Melcer, partner at Lane Clark & Peacock
