Why it’s time to rethink longevity swaps

RHYS MELLENS: Thanks, Howard.

HOWARD JOHNSON: Today we'll be talking about why, if you've not thought about longevity swaps before, or if you have and you've discounted them on grounds of complexity or cost, you might want to think again. Before we do that, though, Rhys, do you want to introduce yourself to our listeners?

RHYS MELLENS: Yeah, so I'm Rhys. I'm a senior director in our transactions team, as you said, Howard. I've been working in the pension risk transfer market for around a decade. And in that time, I've advised on a range of different transaction types, including buy ins, buyouts, and longevity swaps, which is what I'm here to talk about today.

HOWARD JOHNSON: Great. And we've been pretty busy in recent years with longevity swaps. Do you just want to explain the type of work WTW volumes?

RHYS MELLENS: Yeah, so we've been active in the longevity swap market since the first swaps were written back in 2009. Since then, there's been over £170 billion of longevity swaps written by UK pension schemes. And we've led the advice on over £100 billion of those. So very active in that market. And our role is helping trustees and sponsors all the way through the process, from setting their strategy at outset to finding providers, executing contracts, and then helping them to manage the longevity swaps on an ongoing basis.

HOWARD JOHNSON: So the right person to be talking to today. We'll talk a bit about why they might appeal more broadly today. And also we're going to talk through an exciting new innovation at WTW. And you've been part of developing, Rhys, our longevity stream solutions. So we'll talk about how that will make it much simpler for schemes of different sizes to access longevity swaps.

Before we do that, I've just got some short questions to ask that will give I, guess, a bit of signposting for the rest of the episode. The first of those is if you were a trustee of a £250 million pound pension scheme, so a decent sized scheme, but certainly not a supertanker. Probably not the large size scheme that we would traditionally associate doing longevity swabs. Should longevity swaps now be on your radar?

RHYS MELLENS: Absolutely, yes. Five years ago or so, I probably would have said no. It's not likely to be relevant or viable for you. But in the current climate, and with new solutions like longevity stream, absolutely I do believe that you should be thinking about this.

HOWARD JOHNSON: Yeah, and we can unpack a bit on why that is later on. Second question, to do a longevity swap, do trustee boards need significant expertise on their side? For example, an independent trustee who's done it before.

RHYS MELLENS: No. I think it can help. If you've been through the process before, then yes, you know some of the pitfalls and it will help you. But absolutely not essential.

HOWARD JOHNSON: Yeah, I guess particularly with the longevity stream solution, if that will simplify the process, that should help those trustee boards that are, I guess, have that lower governance level typically.

RHYS MELLENS: Yeah. agreed.

HOWARD JOHNSON: Is longevity swap pricing is good now, as we're likely to ever see? It's a difficult one.

RHYS MELLENS: Yes, I would say so. But I will caveat that one, if that's OK. So I think if you'd asked me that five years ago, I probably would have said I don't think it could get to the levels that it's at today. So I could be wrong on that. But I don't think there's a lot of scope for it to improve much further, given how low longevity swap costs are now.

HOWARD JOHNSON: Yeah.

RHYS MELLENS: It is as attractive as we've ever seen it in terms of pricing.

HOWARD JOHNSON: That's a positive for anyone who's thinking about this. And we'll explore why that there is that good pricing at the moment slightly later on. Last question is, what's a common misunderstanding that people often have around longevity swaps?

RHYS MELLENS: So I would say the idea that longevity swaps are difficult to transition to a buy in and buy out. Again, I think that was something that five, 10 years ago was true to an extent. But that was some of the first longevity swaps that were innovated. Actually, what we've seen since then is the market naturally has become more efficient at that process. And around 25% of the schemes that have done longevity swaps have now gone on to successfully navigate to a buy in or buy out. So it's much more tried and tested. And so, no, in our view, it's not hard anymore. But I understand why some people still believe that might be the case.

HOWARD JOHNSON: OK, great. We've got a few little bits of signposting there. So we'll now go back into the main content. So I guess first of all, lots of listeners here won't have thought much about longevity swaps. I guess in the past have been something those much larger schemes have typically been interested in. So for people who are not familiar with them, do you want to just explain what a longevity swap is and how it works?

RHYS MELLENS: Yeah. So a longevity swap protects schemes against the risk that their members live longer than expected. There's no direct impact on the members, so the scheme continues to pay pension payments as normal. But if the members live longer than expected, the counterparty to the longevity swap will reimburse the pension scheme for the additional costs. And in exchange for that, the scheme will pay a series of fixed payments based on an agreed set of life expectancy assumptions at outset. So you're basically swapping an uncertain set of cash flows for a fixed set of cash flows that are much more predictable for the scheme.

HOWARD JOHNSON: Yeah.

RHYS MELLENS: An important feature of longevity swaps is that there's no upfront premium, unlike a buy in or a buyout. So the scheme can continue to control its assets whilst reducing longevity risk.

HOWARD JOHNSON:  So you're locking into a specific longevity assumption or life expectancy assumption that the insurer sets. And I suppose then, I guess, you want it's good that there are several reinsurers you can speak to. And you you'd go with the one that's got the best deal, as well, wouldn't you, presumably?

RHYS MELLENS: Yeah, exactly. You'll line them all up and look at who's got the lowest life expectancy assumptions, and what fees they're charging as well. And then you take that all into account in your pricing analysis when picking the reinsurer.

HOWARD JOHNSON:  Yeah. And I suppose, so the key outcome here is it immunises your scheme's funding level to future changes in life expectancy assumptions. And I guess, the big risk there is, if there's some of miracle drug comes out that can cure some of the significant diseases that are out there. Obviously, that would be amazing for the human race. For pension schemes, that would be a financial strain. So if you've locked in your longevity risk with longevity swap, you wouldn't suffer a reduction in your funding level if something like that were to happen?

RHYS MELLENS: Exactly, it works much like interest rate or inflation hedging through LDI. And yeah, you mentioned potential for life expectancy to increase. Things like AI, certainly a lot of question marks out there at the moment about what could happen for future longevity.

HOWARD JOHNSON: Yeah. And you mentioned LDI there. And I guess that's something that's been on a similar, does a similar thing. So I guess lots of pension scheme trustees and sponsors are used to how LDI, or liability driven investments, they immunise you against changes in long term bond yields and inflation. And this just does a similar thing for longevity, doesn't it?

RHYS MELLENS: Exactly.

HOWARD JOHNSON: OK, that's great. So in the past, they've been the preserve of much larger schemes. Why are they likely to appeal to a broader set of pension schemes now?

RHYS MELLENS:  Yeah, so I think there's several reasons. And they all seem to be coming together at exactly the same time. So we've already touched on pricing being at record lows. So that's obviously attractive to schemes of all shapes and sizes. Secondly, the market has evolved quite a lot, particularly for non-pensioners. So most of the longevity swaps written in the past were for pensioners only. That's because it's more simple. There's no optionality around when members retire, that type of thing. So it's easier for the reinsurers to price.

That's no longer the case. The growth in the full scheme buy in and buyout market has meant that reinsurers, to be able to re-insure those buy ins, have had to adapt their solutions. They've become much more efficient at hedging non-pensioners. That's led to more capacity, but also much better pricing.

HOWARD JOHNSON: Yeah.

RHYS MELLENS: Thirdly, we've seen an increase in schemes looking at run on, so with the potential to generate and share surplus. And with schemes that are looking at that type of proposition, longevity risk is likely to be one of, if not the biggest risk, that they're still running. So in order to reduce the risk that surplus disappears or reduces, then they may want to take longevity risk off the table.

Also, we've seen a number of schemes who are planning to do a buy in, but aren't quite in a position to do so yet, and wanting to take one of the biggest risks for buying pricing off the table. So if life expectancy increases, the cost of reinsurance goes up. So does bulk annuity pricing. So if you can lock in at what is an attractive time, then that takes the risk off the table that pricing increases in the bulk annuity market because of life expectancy changes.

HOWARD JOHNSON: Yeah, so you protect that, make that journey to buy out a bit more stable and predictable.

RHYS MELLENS: Yeah, more certain. Yeah, exactly. And then lastly, I guess, what we're seeing with life expectancy in the UK. So after probably a decade or so of reducing expectations of life expectancy, we started to see a bit of a reverse in the last few years. So CMI models, the most recent CMI model, increased liabilities. I think the one before that as well. And we've also seen in 2026 to date, some of the lowest death rates on record.

So it does seem to be a bit of upward pressure on life expectancy, which means it, kind of, brings into focus the fact that there is still this meaningful risk out there for longevity. And so I think it is a sensible step for schemes to be considering whether they should take that risk off the table in some way or other.

HOWARD JOHNSON: Yeah, yeah. And a couple of interesting things just to pick up on there. I guess, first of all, you've talked about pricing and how that's really good at the moment. Could you talk generally about what's driving that good price increase?

RHYS MELLENS:  Yeah, so there's two elements of pricing. There's the view that reinsurers have on life expectancy assumptions. And as you say, over the last few years that's been coming down until very recently. But I guess the other thing that's changed is that reinsurers charge a fee for taking the risk. They're not doing this for free. They expect to make some profit. But the market is so competitive. There's 10 active reinsurers at the moment. That's driven pricing down.

I mentioned earlier, it's become more efficient as well for non-pensioners. So that's helped. And the other thing that's changed a lot is the increase in global yields over the last few years. So higher yields means the reinsurers need to hold less capital against this risk so they're able to provide lower fees. So yeah, a few reasons there why pricing really is attractive at the moment. Yeah.

HOWARD JOHNSON: So in terms of actually entering into a longevity hedge swap deal, how does that actually look in practice? And yeah, how would schemes go about doing that?

RHYS MELLENS: Yeah, so it's probably more familiar to trustees and sponsors than you might think. So it's actually quite similar to a buy in. So you have the same process with getting your data ready and documenting your benefits. You approach providers to get quotes. You then pick your providers and you implement a contract. And then there's a series of onboarding actions. So that's all quite similar.

There are some differences as well. So certainly, on pricing you get more transparency over the pricing assumptions around things like life expectancy. So it becomes a bit more of a technical negotiation there.

HOWARD JOHNSON: Yeah.

RHYS MELLENS: The contracts are a bit more complex as well. So there's ongoing activity once the longevity swaps been onboarded to do things like monitoring payments and collateral. So you need to have provisions in the contract for how all of that will work. So there's a bit more work to do on contracting as well. And then, I guess, ongoing, I mentioned already, but there's some work once it's up and running to make sure that you're monitoring those things.

HOWARD JOHNSON: Yeah, so that initial negotiation as well, I think you made the point earlier that, well, you're dealing with reinsurers here as well. And so there's around 10 of those in the market. So it's a nice, busy market, very competitive. How does dealing with a reinsurer differ to dealing with an insurer, the type that would write bulk annuity business?

RHYS MELLENS: Yeah, I guess the biggest difference there is that for most buy ins and buyouts now, one of the biggest considerations for pension schemes is what does the member experience look like when those members are ultimately facing the insurer. So that is the key, one of the key

HOWARD JOHNSON: Yeah, of doing a buy in.

- --selection criteria now.

HOWARD JOHNSON: Yeah.

RHYS MELLENS: That's not really a consideration for a longevity swap because there's no change to the member experience at all. They'll never face the reinsurer. So it does become much more about things like price and commercial terms.

HOWARD JOHNSON: Yeah.

RHYS MELLENS:  And I guess experience of the reinsurer as well is something that trustees and sponsors will take comfort from.

HOWARD JOHNSON:  Yeah, OK, so different factors coming into negotiation.

RHYS MELLENS: Yeah.

HOWARD JOHNSON:  And how do we tend to help trustees and sponsors with that decision making process when they've chosen to go down this route?

RHYS MELLENS:  Yeah, so I guess deciding to go down the longevity swap route in the first place is quite a big decision for pension schemes. We have a lot of debates with trustees and sponsors about what might happen with future longevity.

HOWARD JOHNSON:  Yeah.

RHYS MELLENS:  But actually I think the most important question should be, are we comfortable with running the risk? Because even if you have a certain view, or a strong view, on life expectancy, you might be wrong. And then it just comes down to working out what are your priorities for what are of the risks that pension schemes you're managing? What do you need to address first? Is longevity risk one of those? And then how does the cost of hedging longevity risk compare to the benefit of removing that risk?

HOWARD JOHNSON: Yeah. And I suppose the alternative would be hold a reserve, for example. But I guess that if you're having to hold that reserve, that's money that if you're doing a surplus release, you're either paying back to the employer or planning to pay that to members in the form of benefit improvements. That's money that you can't release in that way.

RHYS MELLENS:  Yeah, and the reserve will be limited to the extent of the reserve. So I guess, in a very extreme life expectancy scenario, then the scheme would be unprotected against those, that longevity shock. So yeah, whereas the insurer reinsurance market will protect you in that scenario.

HOWARD JOHNSON:  Yeah, larger downside risks.

RHYS MELLENS:  Yeah.

HOWARD JOHNSON:  OK. So let's now talk about longevity stream.

RHYS MELLENS: Yes.

HOWARD JOHNSON: So I guess first of all, maybe a bit of background on why we've developed this, where it's come from.

RHYS MELLENS:  Yeah, so the market for longevity swaps has been primarily focused on the larger pension schemes in the UK. And we've had conversations with clients over a long period of time. And the smaller mid-sized clients often will cite the same barriers as to why they haven't explored longevity swaps. So we hear a lot that it's expensive, it's complex to manage, it can be difficult to navigate, that I, sort of, touched on earlier. So all reasons why pension schemes at that size haven't done longevity swaps.

What we've tried to do with longevity stream is to eliminate those barriers. So we've used our experience of the longevity swap market, but also our relationships with providers in that market to build something that takes those barriers away and makes it much more efficient for pension schemes to do longevity swaps. And there's a few key features of it. So there's a panel of global reinsurers that we've selected who will provide pricing. We've partnered with Zurich as the insurance intermediary to facilitate the transaction, getting access to the reinsurance market.

HOWARD JOHNSON: Yeah, so trustees can't deal directly with reinsurers in the way that you can with insurers. You have to insurer sat in the middle, don't you?

RHYS MELLENS: Yeah, you need an insurance license in the middle. And Zurich will provide that, but on a purely pass through basis. So they wouldn't be keeping any risk. It also features pre-negotiated contracts. So we've partnered with CMS to develop those. And those contracts will importantly include the flexibility to move to future buy in or buy out if desired.

HOWARD JOHNSON: Very helpful.

RHYS MELLENS: Yes. There's a streamlined operational framework once the swap is up and running with some unique and new features, which should make the ongoing management much more straightforward for pension schemes. And importantly, significantly reduced fees compared to traditional longevity swaps. And we've got fixed fees for this as well.

HOWARD JOHNSON:  It's going to be-- yeah, have a major impact. So hopefully this is, essentially, simplifying the process. We've got a panel of reinsurers that we're confident will give good pricing. I guess there's a question there around the panel, because you're saying there's 10 reinsurers active in the market. Our panel will be a subset of those who we're confident give good pricing, and good commercial service, presumably. Do we think, do we think you'd still get as good pricing dealing with the panel compared to the wider market?

RHYS MELLENS: Yeah, it's a fair question. And one we've given a lot of thought to. Yeah, in our view, the benefits of having a panel outweighs the potential drawbacks. So what we've got with the panel is a commitment to provide pricing. So you said there's 10 reinsurers in the market, but they're not quoting on every case. So if you were to take one of these transactions that are in the size of where we're looking at for longevity stream to market, they might only get a few quotes anyway. We've basically guaranteed access to that pricing. So the scheme still benefits from competitive pricing, but also a much more efficient process.

HOWARD JOHNSON: Yeah, that sounds fantastic. And yeah, hopefully it just broadens the number of those schemes who are perhaps frustrated that they didn't feel able to access longevity swaps previously and locked down what is a key risk, certainly for de-risked, pension schemes is a massive remaining part of that risk. It will hopefully enable many more of those to lock that down and benefit from that. OK, I think that brings us to everything I was wanting to cover. I don't know, Rhys, are any final remarks you wanted to make or any other details?

RHYS MELLENS: I guess the last point I'd make, and I probably touched on this already, is that the longevity swap market has changed a lot in the last few years. So many pension schemes that wouldn't have considered this five years ago, I think absolutely should be considering it now. That doesn't mean all schemes should be doing a longevity swap, of course. But I think they should be thinking about whether it's right for them.

HOWARD JOHNSON: Appreciate-- I'm going to put you on the spot here, appreciating things are still moving. And I think you were saying five years ago, there are some schemes where this wouldn't make sense, where it does now. Are there any schemes where this possibly still doesn't make sense, just to avoid people going down blind avenues?

RHYS MELLENS: Yeah, I think if you're looking at doing a buy in the next year or two, then you'd need to weigh up the risk that you remove over that period. So longevity risk over the next year or two versus the cost that you'd pay to implement it. So yeah, there certainly are some schemes where it's not right. And others will take a view that having a longevity reserve is sufficient and they're comfortable with that. And those extreme longevity shocks are significantly unlikely, that they don't need to go down this route. But for anyone else, and even those schemes, I suppose, I think it's worth considering whether this is right or not for you.

HOWARD JOHNSON: Yeah, OK. And if trustees want more information, should they get in touch with you? Should we put your contact details on the show notes?

RHYS MELLENS:  Yeah, please do. Yeah, get in touch with myself or anyone else in our risk transfer team. We'd be very, very happy to talk about this.

HOWARD JOHNSON: And in terms of longevity stream as well, our new offering in this area, there's going to be a dedicated web page for that as well just to explain a bit more background. So we'll put a link to that on the show notes as well: https://www.wtwco.com/en-gb/solutions/services/longevity-stream.  Before we finish, I just want to remind our listeners, we had our pensions risk transferring focus event that was due to happen in June this year, we had to defer it because of planned tube strikes that were then cancelled in the end.

That's now been moved to the sixth of October. So I just want to remind people that that's going ahead then. It's going to be at our WTW Lime Street office in London. And we'll put a link to that event in the show notes as well, so people can register for it easily: https://events.wtwco.com/event/18feb71c-2020-419f-a981-dba54bbdd244/summary?RefId=Summary. And with that, I'd like to thank Rhys for joining us today. Thank you, Rhys.

RHYS MELLENS:  Thank you.

HOWARD JOHNSON:  And thanks to our listeners. If you enjoyed today's episode, please look out for future episodes dropping every other Wednesday. And also, in order to support the podcast, please subscribe for future episodes. Thank you. Thank you for listening. This podcast is for informational purposes only and does not constitute financial advice. The views expressed by hosts and guests are their own, and may not reflect those of their employers or affiliated organizations. All content is protected by copyright.