How does a longevity swap work for pensions?

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AcadiFi · Accepted Answer

A longevity swap is a contract between a pension plan and a counterparty (typically a reinsurer) where the plan pays a fixed stream of cash flows based on expected mortality and receives floating cash flows based on actual mortality. If retirees live longer than expected, the plan receives net inflows, offsetting the increased benefit outflows. The plan is protected from longevity risk — the tail where medical advances or health improvements extend life expectancy. Contract structure. Notional: often a fraction of total retiree liability, say $2B out of $5B. Tenor: 10-30 years, covering peak mortality risk window. Fixed leg: plan pays reinsurer expected benefit cash flows based on mortality tables (e.g., Pri-2012 with MP-2022 improvement scale). Floating leg: reinsurer pays plan actual benefit cash flows. Net payment each period = actual minus expected. For Westmere Larkton Pension with $5B liability and $2B longevity swap on retiree subset: if actual retiree deaths in year 3 are 180 vs 200 expected, the plan needed to pay more benefits than expected, and the swap pays the plan the shortfall difference. Pricing. Longevity swap pricing includes an insurance margin of 3-5% of expected cash flows to compensate the reinsurer for tail risk and capital costs. For a $2B notional, upfront-equivalent premium might be $80-120M embedded in the fixed leg. Tradeoffs. Pros: targeted longevity hedge without giving up investment returns, cheaper than a buyout for partial coverage. Cons: counterparty credit risk (often mitigated with collateral), long-tail commitment, complex accounting. Used widely in UK; growing US adoption.

How does a longevity swap work for pensions?

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