A contract by which a pension scheme exchanges its uncertain pension payments for fixed ones, transferring longevity risk.
The longevity swap is a transfer instrument by which a pension fund or insurer pays a reinsurer fixed payments, calculated on an expected life expectancy, and receives in exchange payments corresponding to the pensions actually due. If the beneficiaries live longer than expected, the reinsurer bears the extra cost, which covers the scheme against longevity risk. This instrument, alongside reinsurance and buy-out and buy-in operations, dominates the longevity-transfer market, which remains almost entirely a reinsurance market rather than one of negotiable securities. The risk thus migrates toward the large reinsurers able to offset it with their mortality portfolio, for want of a capital market able to absorb its horizon of several decades.
A pension fund enters a longevity swap with a reinsurer, thus protecting itself against the cost of its retirees' life expectancy exceeding its projections.
longevity swap, échange de longévité