Longevity swaps transfer the risk of pension scheme members living longer than expected from pension schemes to an insurer or bank.
The trustees of the pension scheme agree to pay a fixed series of payments, representing the expected benefits payable under the pension scheme plus a fee.
In return the swap provider pays the benefits that fall due, based on actual scheme mortality.
The benefit to trustees is that they have certainty over the payments that they are expected to make, even if scheme members live longer than expected.
Longevity swaps can be either a swap issued by a bank or an insurance policy issued by an insurer.

Trustees should produce a benefit specification summarising the benefits under the scheme (in particular, revaluation and increases to benefits and contingent benefits).
They should carry out a data cleanse and existence check to ensure scheme data is up to date and accurate.
Consideration should be given by trustees to any collateral requirements and any due diligence requirements on counterparties.
Consideration should be given by trustees to whether protection is sought against scheme-specific longevity or the longevity experience of an index.
Trustees should produce a request-for-quotation document to be shared with potential swap counterparties.

As a longevity swap is a long-term contract the strength of the counterparty is a key part of the trustees' decision-making process.
Banks and insurers are subject to different regulatory capital requirements and failure regimes, and therefore the trustees may need to consider this when deciding which counterparty to choose
Trustees should conduct due diligence on the counterparty and ensure suitable contractual protection and collateral arrangements are in place.

One way of mitigating counterparty risk is to ensure the contract is collateralised, so that the trustees have access to part of the sums due under the contract should the swap counterparty (bank) or insurer fail.
The amount and frequency of collateral posting are key commercial terms.
The trustees will need to ensure that they have sufficient liquid assets to post as collateral, and that they have a process for posting the correct amount of collateral and checking that they are receiving the correct amount. Trustees would usually appoint a collateral manager for this purpose.

Due to the long-term nature of the contract, both parties will want to ensure that the contract can only be terminated in limited circumstances.
The swap counterparty may want a right to terminate the contract where the scheme's funding level has fallen significantly.
The trustees may seek termination rights in the event that the swap counterparty's financial strength deteriorates.

A longevity swap is an investment, and therefore the trust deed and rules should be checked to see if they give the trustees a sufficiently wide power to enter into the transaction.

Entering into a longevity swap manages a scheme's longevity risk, but does not deal with Investment, inflation and other risks.
Ultimately the trustees and sponsoring employer may want to purchase annuity policies or otherwise secure the scheme's liabilities and the trustees and employers should negotiate as to how the longevity swap would be treated if this was to happen.

The trustees will be required to provide the swap counterparty with certain information under the contract on a regular basis.
In particular, the trustees are likely to be required to notify the swap counterparty of deaths on a regular basis and to carry out regular existence checking and notify the swap counterparty of the results.