Virus deaths to trigger margin calls on longevity swaps

IFR 2328 - 11 Apr 2020 - 17 Apr 2020
7 min read
Christopher Whittall

Mounting deaths from the coronavirus could soon trigger margin calls for corporate pension schemes from a little-known source: the more than £80bn of swaps contracts many hold to hedge against their pensioners living longer than expected.

UK companies have found so-called longevity swaps to be a useful tool over the past decade to pass on some of the risk of their pension scheme members beating assumptions on life expectancy. Now, as markets reel from the impact of the extraordinary spread of Covid-19, there is perhaps no corner of finance affected more directly by the thousands of deaths coming as a result of the virus.

Actuaries say there is still a good deal of uncertainty over the longer-term impact of Covid-19 on mortality expectations. In the nearer term, though, consultants say the virus is encouraging pension trustees to shelve new longevity swap deals.

As for the billions of longevity swaps already in existence, the uptick in UK deaths means pension schemes will likely have to post more collateral to the re-insurers that provide these swaps if mortalities increase faster than models underpinning the transactions had predicted.

“Naturally if we have a lot of deaths coming through, there will be an increase in [the] amount of collateral that schemes will need to place to reinsurers," said Baljit Khatra, a senior risk transfer consultant at Hymans Robertson.

"We’re saying to schemes with existing longevity swaps: make sure you have enough liquidity to answer any collateral calls.”


The UK is at the forefront of longevity swap activity thanks to the large number of companies with defined benefit pension plans. These schemes, where employers provide retired staff with a specified level of payout, are mostly closed to new members now. But there are still around 10.5m members of such schemes spread across about 14,000 employers handling roughly £1.5trn in assets, according to a 2018 UK government report.

Longevity swaps emerged over a decade ago as one way for companies to offload the risk of pensioners living longer than expected and saddling them with expensive unexpected payments.

Today, there are about £81.5bn of existing pension fund longevity swaps outstanding, according to Hymans Robertson, with AstraZeneca, British Airways, BT, ITV and Rolls-Royce among the companies to have used these products.

In a typical structure a pension scheme makes regular fixed payments to a swap provider based on mortality assumptions about its members – essentially how much it is expected to pay out to pensioners over the course of the swap.

The swap provider (usually a re-insurer) pays the scheme a regular variable amount in return, based on members who are alive at that time. That means if pensioners live longer than expected, the re-insurer has to make up the shortfall.

These regular payments are usually settled on a net basis every month or quarter, while collateral – typically cash or investment-grade bonds – is also exchanged to provide security against the risk of default on any future net payments.

If Covid-19 results in scheme members dying faster than models underlying these swaps had predicted, the models would automatically adjust to take these additional deaths into account and to reflect any implied acceleration in mortality rates. That would trigger collateral calls for the pension scheme to cover the anticipated rise in net payments it would face in the future.

“We expect unfortunately [Covid-19] will lead to a higher mortality compared to the original pricing assumptions supporting the transactions,” said Cedric Fetiveau, co-founder of Dedomainia, a financial technology company focused on bringing greater efficiency to the longevity risk transfer market.

“This experience will be captured by the model supporting the valuation of the trades and will generate some collateral movement between parties,” he added.


Despite the shifting outlook, consultants believe pension schemes and re-insurers are unlikely to demand a so-called mortality basis review just yet for these swaps. That action involves asking for a reassessment of the models underlying the swaps if there is thought to be a permanent change in assumptions around life expectancy of scheme members.

Khatra said his firm was advising pension schemes to start thinking about reviews, though it’s probably too early for specific action.

“There's no point doing a mortality review without knowing the facts. At the moment, there are a lot of unknowns and a very mixed bag of views,” he said.


Longevity swaps typically involve people receiving pensions for 15 to 20 years, limiting the impact one year of mortality data can have. Around 600,000 die in the UK every year, with a normal annual variation of plus or minus 10,000 and sometimes even higher, according to Tim Gordon, a partner in the risk transfer group at AON. For instance, the difference between 2014 and 2015 (after adjusting for trend) was around 25,000 deaths.

"A one-off year with excess UK deaths of, say, 20,000, does not move the dial much in this context," he said.

Gordon says they are currently predicting fewer than 30,000 deaths in the UK in 2020 from Covid-19, some of whom would have died anyway because of underlying conditions.

"It’s also worth bearing in mind that, until the crisis, 2020 had been a light mortality year to date. There is a lot of uncertainty, but it's possible that 2020 overall could be a relatively 'normal' mortality year," said Gordon.

"More extreme scenarios are also possible, although in those circumstances we expect the government to take measures to address that," he added.


Gauging the longer-term impact that Covid-19 will have on life expectancy is trickier still. It is very hard to predict, for instance, what second-order effects such as the economic fallout from the crisis will mean for mortality rates.

"A severe recession could impact health and social welfare spending, which is negative for longevity," said Gordon. "That said, the frontline role of the NHS in the crisis and greater social cohesion could see strong support for higher health and social welfare spending, which is positive for longevity."

Pension trustees will most likely hit pause on new longevity swap transactions given the considerable uncertainty, consultants say. This could lead to a wave of deal-making next year if things have settled down. Wider credit spreads, potentially higher inflation and higher mortality rates could create market conditions that encourage pension schemes to enter longevity swaps.

“It will be more affordable for pension schemes to enter into de-risking transactions. That could lead to a lot of deals in 2021. The question is whether the market can absorb all of them. There was already a bit of a bottleneck before the crisis,” said Fetiveau.