Longevity Swap

Insuring against people living longer than planned

A pension scheme’s greatest uncertainty is not markets but mortality: it owes payments for as long as its members live, and nobody knows how long that is. A longevity swap exchanges a fixed schedule of payments, agreed today on assumed mortality, for the payments the scheme actually has to make. If members live longer than assumed, the swap pays the difference for as long as it lasts — which can be fifty years.

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What the lesson covers

1. What it is
2. Who takes the other side
3. Indemnity and index
4. Why it’s used
5. Risks to watch

Key terms

• Longevity risk — The risk that members live longer than assumed, so a scheme pays pensions for more years than it funded.
• Fixed leg — The pre-agreed schedule of payments based on assumed mortality, plus the counterparty’s margin.
• Floating leg — The actual pension payments made to the covered members, however long they live.
• Indemnity swap — A hedge referencing the scheme’s own members, matching exactly but requiring detailed data.
• q-forward — A forward on a published mortality rate for an age cohort — the standardised, index-based alternative.
• Basis risk — The gap between a scheme’s own members and the national population an index hedge references.

Every key term, A to Z

In practice

UK and Dutch pension schemes are the main users, with insurers and reinsurers on the other side and investment banks often intermediating. The transactions are large, slow to arrange and heavily negotiated on collateral rather than on price, because both sides know the price is the easy part of a fifty-year contract.

Read next

• Catastrophe Bond — A coupon that stops if the hurricane arrives
• Interest Rate Swap — Trade fixed for floating payments
• The gilt LDI crisis, 2022 — Pension hedges that worked, and could not be funded

In the app, Longevity Swap carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

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Educational content only. Nothing here is financial advice, an offer to trade, or a recommendation to buy or sell any instrument.