The Hidden Cost of Longevity Swaps

Offloading longevity risk is not a one-way transaction, Redington has warned.

Remember that longevity transaction? It may be time to check it’s still doing what it should, a consultant has said.

“While longevity hedging may be appropriate for some schemes recent experience reminds us that this isn’t a ‘one-way’ risk.”Recent updates to long-term mortality data have challenged assumed trends and may require action from pension funds that have hedged their longevity risk, warned Dan Mikulskis, head of asset and liability management at Redington.

His comments followed an update from The Pensions Regulator (TPR) in the UK, which alerted those responsible for running defined benefit funds of the change in mortality trends.

In particular, the Continuous Mortality Investigation (CMI) model used by pensions in England and Wales has shown a fall in life expectancy over the past few years, TPR noted.

“Contrary to longer-term trends, experience in the last five years has implied a lower level of life expectancy,” Mikulskis said. “While this may be ‘good’ news for many schemes in a financial sense, this has particular implications for schemes who have enacted longevity swaps in recent years, as they may need to adjust their strategic asset allocation to allow for the collateral that needs to be posted if and when the contract takes on a negative value.”

Many transactions executed since 2009—including the BT Pension Scheme’s record-breaking £16 billion ($23 billion) longevity swap in 2014—may now have a “significantly negative value,” Mikulskis said. Pensions in this situation should inquire whether their contracts include provisions to review mortality assumptions, he added.

Other high-profile longevity swaps have included brewer Heineken, insurer and fund manager AXA, and the Merchant Navy Officers Pension Fund, all in the UK. In Canada, telecom giant Bell sealed a C$5 billion (US$3.8 billion) deal with Sun Life in 2015.

“It also provides an interesting perspective to debates around longevity risk and the cost of hedging,” Mikulskis said of the mortality data. “While longevity hedging may be appropriate for some schemes, recent experience reminds us that this isn’t a ‘one-way’ risk.”

However, TPR’s own recommendation to UK pensions was less explicit.

“The CMI model is driven by assumptions, one of which is the single long-term improvement rate,” TPR said, “and we would consider it unlikely to be appropriate to make any changes to this assumption until it is clearer that recent experience is indicative of being a trend over the longer term.”

Related: Longevity Improvements Hit the Brakes; Pensions to Save $18B from ‘Outdated’ Mortality Tables; Time Running Out on Longevity Risk, Warns OECD