UK - Babcock International has confirmed trustees of its Davenport Royal Dockyard defined benefit (DB) scheme have signed a longevity swap agreement with Credit Suisse to cap £300m (€328m) of its pensioner-in-payment liabilities.

Babcock announced in its preliminary results last month that it expected three of its pension schemes to hedge their exposure to longevity in 2009, covering around £750m of pension liabilities. (See earlier IPE article: Consultants predict potential longevity market of £15bn)

The company confirmed the first of these three transactions is now complete, as the group’s four DB schemes - which had assets of £1.7bn and a £52m surplus in March 2009 - have around £800m in liabilities relating to pensions in payment and the longevity swap deal signed yesterday will cap the longevity risk for £300m of these.

The arrangement with Credit Suisse is the first transaction of its type in the UK occupational pensions market, although Babcock confirmed further transactions to cap an additional £450m of pension in payment liabilities is expected to be completed by the end of September 2009.

Steven Dicker, senior consultant at Watson Wyatt, which acted as lead adviser, said: “This flagship deal heralds the launch of a new market in longevity risk. Longevity swaps have been talked about for years but, until now, there was no precedent of a satisfactory contract being drawn up. By demonstrating the technical obstacles can be overcome, a dockyard better known for supporting the Royal Navy’s battleships and submarines has boosted the armoury of trustees and employers who want to reduce pension risks.”
 
Under the terms of the contract, the pension scheme will swap pre-agreed monthly payments to Credit Suisse in return for monthly payments dependant on the longevity of the scheme’s 4,500 retired members, who currently have an average age of 67.

Dicker explained: “The scheme is locking in the payments that would be due if there were no swap and if its pensioners lived slightly longer than Credit Suisse expects them to. If longevity improves faster still, the swap will meet the extra cost.”
 
Watson Wyatt highlighted the importance of “counterparty risk” because of the length of the agreement, and revealed the deal required the party that is expected to make net payments in future “to post collateral under International Swaps and Derivatives Association rules”.

“The rules determining who needs to put up collateral and how much are a crucial feature of any swap contract. This is more complicated in the case of a longevity swap than with interest rate or inflation swaps. You don’t just need to record which members are still alive at regular intervals - you also need an agreed method for measuring how long they are expected to live and how this has changed since the agreement was drawn up,” said Dicker.

However, he said capping longevity risk can avoid the need for an up-front cash injection from the sponsor and the sale of assets at current prices, “so these solutions may prove popular in an environment where employers are cash-constrained and want investment returns to help eliminate deficits”.

“Quotes for longevity hedges have become more competitive over the past few months and pension schemes will be conscious that early buyers could get a good deal,” added Dicker. (See earlier IPE article: Longevity swaps - buy now while stocks last?)

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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