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Written by:

Ross Hamilton

Actuary for Funding and Fiduciary

Read Time:

5 minutes

Published:

21 / 08 / 2023

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Understanding and managing longevity risk

For many Defined Benefit (DB) pension schemes, longevity risk is one of the largest unrewarded investment risks they face.

Managing this risk is important because, put simply, if members live longer than expected, scheme benefit payments will be higher than expected – increasing the value of the scheme’s liabilities, and potentially increasing the level of cash contributions required from the sponsor.

Whilst every scheme is different, one way to manage this risk is by entering a longevity swap, which fixes the view on life expectancy, providing a less volatile funding position and more predictable cashflows in the future.


What is a longevity swap?

A swap is where two parties exchange a set of cashflows, based on a particular risk factor.

In a longevity swap, the pension scheme makes a series of payments linked to the view on longevity (the ‘fixed’ cashflows) at the time of pricing, while the reinsurer makes a series of payments based on the actual scheme experience (the ‘floating’ cashflows), all in respect of members referenced by the swap.

The swap itself is an asset of the scheme, providing a cash inflow or outflow depending on its future performance and there is no impact to the benefits member receive from the scheme.

In the event that scheme members referenced by the swap live longer than expected, leading to a rise in benefit payments, the swap is intended to offset most of this increase by providing a corresponding income to the scheme.

The typical providers of longevity swaps are global reinsurers with large books of mortality risk from products such as life insurance. However, reinsurers do not hold the necessary permissions to transact directly with a UK pension scheme, and therefore, an insurance intermediary is required.

A ‘direct-to-scheme’ longevity swap requires the scheme to undertake the following activities: data and pricing analytics, commercial negotiations and deal execution, as well as stakeholder management and ongoing operations.

At Brightwell, we have taken a fresh and integrated approach to meeting these requirements – illustrated by our support for the latest longevity swap undertaken by BT Pension Scheme (BTPS).


Data and pricing analytics

In recognition of the fact that each pension scheme has bespoke data preparation needs, Brightwell undertook data analysis to ensure it was of the right quality to present to the reinsurance market. This involves cleansing, transforming, and in some cases, amending the original data.

Pricing a longevity swap involves processing member data into pension cashflows, using assumptions provided by the reinsurers.

For large schemes, this generates huge quantities of data, which has historically created some challenges. Using state-of-the-art data science tools, we have created bespoke models for BTPS that overcome these issues, producing fast and detailed analysis.


Commercial negotiations and deal execution

Brightwell services BTPS across the board – from administration to funding, fiduciary and investment operations – underpinned by group functions such as finance, legal, compliance and HR.

In addition, we facilitated the extension of BTPS’s captive insurer to efficiently cover the second longevity swap and maintain an ongoing relationship to support the captive.

This breadth of services has enabled Brightwell to form a highly integrated deals team, able to manage the broad challenges (including tax, legal and data-related) of undertaking a swap.

Operations

Brightwell provides ongoing administrative requirements to the swap, building out the pricing tool into a bespoke and end-to-end operations model which can be made available to other schemes.

If you’d like to know more about how Brightwell could help you manage your scheme’s longevity risk, do get in touch: hello@brightwellpensions.com.


Avatar photo

Written by:

Ross Hamilton

Actuary for Funding and Fiduciary

Read Time:

5 minutes

Published:

21 / 08 / 2023

Share Article:


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