UK - DB pension schemes planning to offload longevity risk by purchasing swaps should strongly consider buying them now, according to Mercer.

The consultancy has estimated that over the next five years, demand for such products could far outstrip supply, leading to price rises.

By taking out a longevity swap, the pension fund is agreeing to make a series of known payments to the insurer, in exchange for a series of payments dependent on how long each scheme member lives. This means the pension fund is effectively placing a cap on the corresponding liability to each member.However, the scheme retains ownership of its assets.

In contrast, conventional buyouts transfer assets to the insurer, so that the scheme's investment performance is linked to insurance company returns.

Mercer surveyed UK pension scheme finance directors attending the firm's buyout conference last November and found that 20% intend to buy-out their pension scheme within the next five years.

If this were replicated across the £1tn (€1.15trn) of UK private sector DB liabilities as a whole, £200bn-worth of liabilities would be offloaded.

However, Mercer said it has close links to all of the potential counterparties and has estimated that the UK market's capacity for taking on longevity risk from DB pension schemes in the form of swaps or bulk annuities is at best around £50bn over the next five years, equal to only 5% of pension liabilities.

Andrew Ward, consultant with Mercer, said: "While large deficits may prevent schemes from offloading their risk all at once, there is growing interest in reducing risk incrementally over time. Now that Babcock have said they intend to buy a longevity swap, other UK schemes can see that it is possible, and those who have been holding back are likely to follow suit."

He said: "While it is possible that the supply of longevity swaps will increase to meet demand, it is likely that prices will rise in future. If pension funds have a desire to get rid of longevity risk, now could be a good time to do it."

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