A landmark agreement has been reached over the first full transfer of longevity risk from a pension scheme's balance sheet with a pensions longevity swap.

Babcock International Group, the support services company, announced that an 'agreement in principle' has been set with trustees of two of its defined benefit schemes to transfer the risk of members living longer than expected. The scheme is able to fix its payments to pensioners under this contract, regardless of how long they live, by making this deal with a financial institution.

Should pensioners involved in the scheme live longer than anticipated, the institution will cover the extra cost, and vice versa. This differs to a buy-out when both investment risk and longevity risk are transferred.

Clive Wellsteed, partner and head of the buy-out practice at Lane Clark & Peacock, who in their 2008 Buy-out Report predicted that a longevity swap would take place this year, commented: "Longevity swaps are a new and potent tool in the risk management toolkit and we are seeing strong interest from trustees and corporates. Corporate treasurers now have a new solution to the seemingly intractable challenge of pensioner longevity. Now that the crucial first trade is in the home straight, we expect further rapid growth in interest from finance directors focusing on end-game planning for pensions risks.

"Often this end-game will be in the form of a buy-out with an insurance company. The challenge for swap providers is to ensure schemes receive value for money for their swap if ultimately transferred to an insurance company as part of a buy-out. How swap providers rise to this challenge will determine whether this is a market primed to fizzle out or flare up," he added.

- Pensions Age May 2009

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