Longevity Swaps explained
A longevity swap is an alternative way to remove longevity risk
There is no upfront payment required, and so your scheme can retain more assets either to provide additional asset returns in the future or to support an interest rate and inflation hedging strategy. Longevity swaps currently tend to be focused on pensioner members, and while they are available to schemes of all sizes, their complexity tends to mean they are more popular with larger schemes.
A longevity swap generally works as follows:
- The swap provider and the scheme estimate the expected payments that will become due to the scheme’s members, and how long these payments will be payable for.
- The scheme then makes fixed payments, which reflect these expected payments, to the swap provider for the duration of the agreement.
The provider of the longevity swap, in return, pays the trustees variable amounts which are payable for as long as each member survives. In practice, if a member lives only as long as expected, these two payments will cancel. There are several options affecting the structuring of the swap, which trustees should consider carefully to determine which is the best fit for their scheme.
The main benefit for your scheme of a longevity swap, as with a buy-in, is certainty
If the actual payments due to the scheme members who are covered by the swap turn out to be higher than expected because those members live longer, the shortfall has to be met by the swap provider.
Initially, the floating payments and the fixed payments are equivalent (excluding fees), and therefore no money changes hands. In some arrangements, the payments to or from the scheme will be held as collateral.