Still, longevity transfers expose investors to the credit risk of issuers for many years. Once a pension fund agrees to transfer its assets in return for protection against pensioners living longer than expected, they are tied into a long-term contract that can be difficult to unwind, said David McCourt, senior policy adviser at the U.K.'s National Association of Pension Funds. That means the insurer, bank or hedge fund that a pension plan chooses to deal with is important, he said.
'No Going Back'
"There's a massive counterparty risk," McCourt said. "People say insurance companies don't go bust, but they do. We've seen AIG and investment banks going under like Lehman. There's a lot of pressure on the trustees to make sure they're comfortable the deal is right because there's no going back."
Pension funds outside the U.K. also remain hesitant.
APG Algemene Pensioen Groep NV in Amsterdam, which manages 277 billion euros ($396 billion) of assets for seven pension funds, "will not do transactions to actively hedge longevity risk," according to Harmen Geers, a spokesman for the firm.
"The market is unbalanced, since there are no natural counterparties to take up a risk of that size in absolute terms," Geers said.
Life Settlements
There has been less interest in the U.S. because regulatory pressure on pension funds hasn't been as intense as in the U.K., said Pretty Sagoo, director of structuring at Deutsche Bank in London. In the U.S., investors can bet instead on life expectancy through so-called life settlements.
Rather than exchanging assets and liabilities with a pension plan, the life-settlement market allows investors to buy insurance policies from individuals and pay the premiums until that person dies. Investors then receive the death benefits.
The secondary market for U.S. life settlements began in the 1980s when the AIDS epidemic led some patients to sell their insurance policies to pay for treatment. The industry was valued at $2 billion in 2001 and, once it became regulated, quickly grew to a maturity value of $35 billion by 2009, according to Conning & Co., a Hartford, Connecticut-based research firm.