Pension schemes could attain a “meaningful reduction in risk” by using a longevity swap, Aon has said.

Aon Hewitt’s Risk Settlement Bulletin for May explained that for schemes looking to retain investment risk for a long period before annuitisation, a longevity swap could significantly lessen risk and bring schemes closer towards a later annuity transaction.

While this is recommended, Aon noted that it is key that the swap mechanics and contractual terms “allow for ease of conversion to a bulk annuity at a later stage.”

“It is important to have contractual provisions that allow the longevity swap provider, sitting in the middle of a longevity swap transaction, to be replaced with the new bulk annuity provider, without any termination of the contract and the associated financial penalties,” the report said.

Aon added that schemes should also consider the number of reinsurers involved in the transaction for its success. Although trustees are not directly involved with the reinsurers, Aon suggested that the more reinsurers supporting the transaction, the more complex it can be to restructure as a bulk annuity in the future.

Nonetheless the report mentioned: “Whilst simplicity and ease of future conversion is desirable in some circumstances there can be material financial benefit in using a number of reinsurers to support a longevity transaction.”

Looking at current market conditions and risk, Aon’s report also noted that the pricing of annuity contracts “remains attractive” in comparison to the yield available on gilts. The report recommended: “The implied yield on an annuity policy can equate to an effective return above that achievable on gilts and should be strongly considered as one of the options available to secure higher returns whilst reducing risk.”

Share Story: