UK funds keen on longevity swaps over annuities

With two more UK pension funds announcing arrangements to hedge their pensioner liabilities against improvements in longevity there is speculation these DIY swaps may replace bulk annuity buy-ins by pension funds.

According to Watson Wyatt, which was the lead adviser in the latest arrangements – two funds sponsored by RSA Insurance Group – as well as UK’s first – a swap for Babcock earlier this year – advances in longevity swaps and market conditions are leading to the trend.

Paul Trickett, European head of investment consulting for Watson Wyatt, said traditional annuity policies were less attractive than they were a year ago.

He said the DIY approach was likely to catch on because trustees could retain control of how the assets were invested and did not need to sell other assets to enhance returns. There was no requirement for immediate contributions from the sponsoring employer.

“There is also a key benefit of increased ability to manage counterparty risk,” he said.

The arrangements for RSA and Babcock incorporated the added protection of strong collateralisation processes, supported by very high quality bonds,” Trickett said.

“We expect more to follow quite quickly. Given our clients’ significant interest in hedging longevity risk in this way we expect the growth of this market to mirror that of the inflation-linked derivatives market which exceeded 20 billion pounds (US$32.6 billion) last year.”