UK - Pension trustees considering a longevity hedge should ensure the transaction can either be substituted with a contract from the buyout provider or be unwound at a "reasonable" price, if the employer's ultimate aim is a buyout of liabilities, according to a pension manager who has completed such a deal.

Nick Greenwood, pension fund manager for the Royal County of Berkshire Pension Fund, noted in a white paper on longevity that trustees need to consider a wide variety of questions when deciding on a longevity hedge, including the type of deal and the motivation behind it.

His white paper was produced as a contribution to a report entitled Longevity Hedging for Pension Plans.

One of the first issues trustees need to address is what alternatives there are to longevity hedging - such as a buyout or buy-in - and whether these are suitable for the scheme, according to Greenwood.

He warned if the employer's eventual aim is to secure the liabilities with a buyout then "it is the trustees responsibility to ensure that any longevity hedge can either be novated to the buyout provider, or if necessary unwound at a reasonable cost".

He continued: "Failure to do so might well prove most expensive in the long-run and could frustrate a buyout".

Greenwood recognised a longevity hedge might not necessarily suit all trustees or pension plans, so key factors to consider when exploring different options such as longevity swap-based deal or an insurance-based longevity deal are depth of coverage, security and price.

Issues could include whether the hedge continues until the last death of the members covered or if it has a finite life, as well as the details of collateral in a swap-based deal. It could also include details of the security in an insurance-based transaction, such as whether the contract qualifies for compensation under the Financial Services Compensation Scheme (FSCS) if the insurer fails.

But Greenwood added: "Nothing, however, is a substitute for thorough due diligence - reputational as well as financial." He noted an counterparty will be conducting the same checks on the scheme and employer.

That said, while he outlined a number of key issues for trustees to think about, following Berkshire's own longevity transaction at the end of 2009, Greenwood also warned trustees should not underestimate the time it will take to move from an initial decision to hedge longevity to completing the deal. (See earlier IPE article: Berkshire completes first LGPS longevity deal)

"Drafting the agreement is your best opportunity to ensure that your fund's rights are protected. This is a new market and we are all pioneers," he stated.

Noel Hillmann, managing director of Clear Path Analysis - publishers of the Longevity Hedging for Pension Plans report, said: "Over 80% of pension plans we spoke to still feel the biggest hurdle they face in taking on a longevity hedge Is in truly understanding how the structures work and what it takes to put one in place.

"Nick, as an individual who is now very experienced in these structures, has demystified some of the most common hurdles pension groups come up against in taking on a longevity hedge."

The report was produced ahead of the latest longevity signing. Babcock International has now confirmed it has completed the third of three planned longevity swap transactions for its largest defined benefit (DB) schemes.

The company had already completed transactions with Credit Suisse for the Royal Devon Dockyards and Rosyth Dockyards schemes, with the final transaction relating to the Babcock pension scheme.

In its interim management statement, the firm noted its IAS19 balance sheet liabilities will increase by around £25m (€28.6m) from the third quarter figures in September, to reflect the transaction. In the meantime, it said a single cross-scheme investment committee is currently "looking at ways to reduce risk from inflation and interest rate movements". (See earlier IPE article: Babcock eyes interest rate hedge after governance work)

Clear Path Analysis will publish the final report on 9 March 2010. Greenwood's contribution sits alongside the views of over 20 finance directors, pension fund managers and trustees of schemes including Babcock International, West Yorkshire, Merseyside, and the SAUL Trustee company.

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