BNP bond offsets longevity risk


UK pension fund managers are now able to protect themselves against the risk of members living longer than expected by buying a longevity bond. Structured by BNP Paribas for the European Investment Bank (EIB), the offering will help pension funds hedge their liabilities more effectively.

“Pension funds now have a solution to longevity risk and, for the first time, the valuation of their assets will move with the value of the liabilities, a contrast to the former model where assets were disconnected from the liabilities,” says Denis Autier, head of global risk solutions at BNP Paribas in London.

Autier adds that the bond could herald a change in thinking amongst many pension funds. Though they are tied to benchmarks, these benchmarks do not take into account longevity. “Pension funds should consider change. This is a product that is a major step in providing a solution to asset-liability mismatches and management,” he says.

Pension funds either do not bother to hedge longevity risk or decide to enter into expensive insurance contracts. Autier acknowledges that the bond is not a perfect hedge, but is the best one currently on offer. “The bond is significantly cheaper,” he says.

The £540 million issue has a maturity of 25 years and the bond’s cashflow is based on the mortality rate of 65-year-old English and Welsh males, as published by the Office for National Statistics (ONS). As the number of living individuals decline over the years, so do the cashflows.

The bond has been solely placed with UK pension funds, Autier explains, because its structure only works in countries where there is a defined benefit scheme in place. Countries in Northern Europe, such as the Netherlands, follow similar schemes and could also in turn launch parallel products.

How it works

At the fifth anniversary of the longevity bond, the initial population aged 65 has now reached 70. The ONS data may show that 90% of the population has survived to this age. The longevity bond with a fixed annuity of £1,000 would pay 90%, i.e. £900. If instead of 90%, 92% of the population had survived, the longevity bond would have paid £920.

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