Insurance longevity swaps: Illuminating exits

Trustee clients have shown a marked increase in appetite to understand how bulk annuities and insurance longevity swaps can be used to control longevity risk. 

Trustees appear comfortable with buy-ins as part of the scheme’s derisking journey, as buy-in contracts readily provide for future conversion into buyout. This ‘exit’ route releases the trustees from their obligations to the insurer and members, and enables them to proceed with winding up.

Trustees might want to do a buy-in with a bulk annuity provider in the future, but retain the economic benefit of the longevity protection afforded by the swap if the cost of that protection remains financially attractive

Less commonly understood is that longevity swaps can also be structured flexibly to enable the trustees to exit when desired in the future. The key is to set clear exit objectives at the outset and incorporate them into the design of the swap.

Tailor swaps to provide flexibility

Partial termination is particularly interesting: what if, in the future, there is a transaction that requires some, but not all, members’ liabilities insured by the swap to be transferred to a new registered pension scheme?

Is it financially feasible (and permissible under the scheme rules) for some of the insured population to be moved to a bulk annuity buy-in or buyout in the future? A swap provides for these scenarios.

A concern of insurers here will be that the least healthy members are going to be selected to exit, leaving a disproportionate amount of the original longevity risk with the insurer – known as selection risk.

But trustees can agree to provide transparency over the basis of selection and warrant there is no adverse selection, breach of which entitles the insurer to express remedies.

Consider keeping your swap

Another point of interest: trustees might want to do a buy-in with a bulk annuity provider in the future, but retain the economic benefit of the longevity protection afforded by the swap if the cost of that protection remains financially attractive.

This can be done in several ways. For instance, the swap insurer itself could provide the bulk annuity insurance, which can be achieved by incorporating additional provisions into the swap contract to convert it into a buy-in policy. 

Alternatively, the swap insurer might be prepared to ‘move’ the swap away from the trustees, to the bulk annuity provider, so that it operates as reinsurance of the bulk annuity provider’s exposure to the same longevity risk.

It should be non-controversial to agree a set of criteria for a counterparty that will be acceptable to the trustees and the swap insurer in this regard.

There are many other factors to be addressed in designing early exits from a swap and there are likely to be pre-conditions for exercising such rights, such as a minimum ‘blackout’ period and the overall impact of any restructuring being financially neutral for the swap insurer.

But these are commonplace commercial issues that, in my experience, insurers would work collaboratively with trustees to resolve, delivering a swap that flexibly meets the immediate need for longevity risk protection as well as the changing investment needs of the trustees over the life of the scheme.

Jane Childs is head of law firm Mayer Brown’s UK pensions risk transfer group