‘World’s first’ longevity hedge for non-retired pension plan members

The world’s first longevity index hedge against increases in life expectancy for a pension plan’s non-retired members has been completed, says Mercer, which advised on the transaction.

The Pall (UK) fund is paying £70m for a longevity hedge with JP Morgan based on future values of its LifeMetrics longevity index.

anaged by Schroders, the contract is designed to mitigate the risk that non-retired members live longer than expected.

Previous longevity deals have focused on retired members only, making this transaction the first of its kind globally, says Mercer. Hedging against increased life expectancy of pension plan members who have yet to retire has, to date, been problematic due to the long-term nature of the risk and the difficulties associated with accurately hedging pension benefits that have yet to come into payment, it says.

The hedge has a term of 10 years during which the fund’s trustees can choose to adjust the size and composition of the swap or decide on an alternative solution. The transaction requires no up-front cash, so the fund’s sponsoring employer does not need to contribute additional resources. Under the agreement the fund receives a payout if life expectancy improves at a greater rate than specified in the contract, allowing it to offset its liabilities. Mercer says it is in talks with UK and international pension plans that are de-risking, and looking at similar longevity indices for the UK, US, Germany and Netherlands.

Andrew Thomson, chairman of the trustees, says: “Like other pension plans, our fund has been hit by significant life expectancy rises over the last decade. This flexible and innovative arrangement helps us manage the key risk of longevity.”

Gordon Fletcher, risk consultant at Mercer and lead adviser to the trustees, says: “In general, the uncertain life expectancies of people still yet to retire pose a far greater risk to pension plans than those who have retired. Current practice has been to focus on mitigating pensioner risk, so this new transaction marks a huge advance in the longevity risk market place. It is flexible with minimal cash implications on day one and is, therefore, likely to be of interest to many occupational pension plans that are actively de-risking.”

David Epstein, head of longevity structuring at JPMorgan says: “Index-based hedges are particularly well suited to hedging the longevity risk of pension plans with significant deferred and active members.

Andrew Connell, head of liability driven investment at Schroders says: “Index-based longevity hedges represent an important addition to the LDI tool kit by enabling plans to mitigate the longevity risks embedded in the liabilities payable to younger members.”

Martin Bird, head of longevity & risk solutions at Aon Hewitt, says: “We welcome this transaction, as it will begin to open up the options for smaller schemes and for active and deferred liabilities where the cashflows are less clear. We await further standardisation in relation to index transactions from the Life & Longevity Markets Association (LLMA), as it needs a uniform and fungible market to really develop. While the LLMA have started on this process, we look forward to seeing the next development.”