UK - Many of the UK's largest occupational pension schemes would consider paying a premium to hedge out the risks around life expectancy if a market for mortality derivatives developed, new research suggests.

A survey by Hewitt Associates of 52 company schemes, with assets of more than £1bn (€1.5bn) each, found there is significant interest in financial instruments being developed by investment banks that would act as a tool for pension funds to manage their longevity risk.

Robert Meek, principal consultant, said: "There is definitely interest in developing those types of approaches. The challenge is around the practicalities of structuring the financial instruments to make them work for the pension scheme."

In March this year, JP Morgan launched its LifeMetrics Index which is designed to benchmark and trade longevity risk, while in April Credit Suisse revealed it would launch a mortality swap for pension funds.

Deutsche Bank and BNP Paribas have also expressed an interest in this market.

Such instruments demand a fixed rate in return for protection against changes in mortality, and are based on an index constructed around broad population cohorts.

However, Meek added: "The problem pension schemes have is their membership is not representative of the population as a whole. Generally those who are better off are members of occupational pension schemes, and their life expectancy is generally longer, so it doesn't give you the protection you'd want."

Despite this barrier, Meek said the schemes surveyed were more interested in structured solutions to risk management rather than bulk annuity buyouts.

Lynda Whitney, pensions consultant at Hewitt, said: "The continuing development of the buy-out market is leading to more players and continuing innovation, which could well lead to further downward pressure on prices and increases in capacity. However, many companies may not currently have the funds available to make up the gap to the buy-out cost. Among these very large schemes, it would appear that both of these factors are leading to a wait and see mentality."

Research by Bank of New York Mellon Asset Servicing predicts the bulk annuity market will grow to £190bn by 2011.

Investment managers expect traditional and new entrants to the market to capture 20% of the with-profits market and 10% of the defined benefit pension market, according to the study.

Meek commented: "That suggests that a quarter of the market will have moved in the next four years. That's entirely possible. There will be some deals but it won't be a big proportion of the schemes of this size."

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