The growing level of longevity risk faced by defined benefit pension schemes has been well documented and has led to pension schemes seeking solutions to manage this risk.
Such solutions have included pension buy-outs (for example, the General Motors pension buy-out arrangement with Prudential Financial Inc. in 2012), but more recently the trend has been towards longevity swap arrangements.
Typically in a longevity swap transaction the employer sponsor and/or the trustee of the pension scheme will agree to pay fixed monthly amounts to a financial institution or commercial insurer that in return makes variable monthly payments to the pension trustee.
The variable payments are calculated based on the pension amounts that the trustee is obliged to pay to the members of the pension plan. In this way, the risk of members living longer than anticipated (and the liability for pension payments subsequently being more than anticipated) now rests with the financial institution/ commercial insurer, which can then enter into a reinsurance arrangement with one or more commercial reinsurers.
However, using insurance intermediaries (commercial insurers and banks) in these risk transfer arrangements has become increasingly expensive. In response to this, the last year has seen two ground-breaking longevity swap structures being established in Guernsey using a captive insurance company in place of an insurance intermediary, thereby cutting out intermediary fees and removing the need for price averaging.
