UK - Trustees must be "extra careful" about how much they pay for longevity swaps, Trustee GAAPS says.
The warning comes just days after Babcock International announced it was set to complete the first longevity swap deal involving a UK pension fund this month - having reached an agreement in principle with the trustees of two of its defined benefit pension schemes to cap the longevity exposure of nearly all of its pensions in payment - which currently make up around £800m of the schemes' £1.7bn of liabilities (PP Online, May 12).
Trustee GAAPS consulting director David Johnson explained: "The problem with longevity swaps is that there are very few natural end users that would want to take the other side of that swap.
"There are just a few big organisations that actually want to increase their exposure to longevity. If there are very few natural buyers for your risk then you are going to have to pay a lot to get that risk off your hands."
He added: "With such a thin market it will be very hard to assess whether you are paying a sensible price to remove the longevity risk from your pension fund.
"If you are in effect striking a deal where the investment bank is taking your risk onto their book then the bank may want to charge you a lot for that. Not many organisations do well from putting themselves on the other side of a complex derivatives deal with an investment bank.
"Unlike other non-standard risks like hurricanes there are few hedges that an investment bank can take."
Johnson also says that trustees will need to be very careful about the financial strength of the counterparty that a pension fund lays off longevity risk to.
He said: "There is no point in swapping the respectable covenant of the pension scheme's corporate sponsor with the covenant of an investment bank's special purpose vehicle if that vehicle is not well capitalised."
* This comes as Professional Pensions held a Conjecture debate on longevity risk management on May 12.
The debate looked at the latest thinking in relation to longevity risk and the significance for pension schemes - as well as the rapid emergence of the "longevity swap" market.
It examined how longevity swaps can enables pension schemes to transfer longevity risk without handing over all of the scheme assets to an insurer - and discussed current pricing levels on offer.
It also looks at the wider market for longevity risk transfer and takes a view on how life expectancy assumptions in the future.
The debate was hosted by Hewitt Associates principal Kevin Wesbroom and included Hewitt Associates principal and strategic risk consultant Martin Bird, J.P.Morgan pension advisory group executive director David Epstein and Munich Re longevity strategist Paul Sweeting.
Click here to listen to the debate.
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