UPDATE 1-BT pension fund in record deal to offload longevity risk

Fri Jul 4, 2014 6:17am EDT

* 16 bln pound deal the biggest in the UK

* Hedges more than a quarter of scheme's old-age risk

* Takes total UK issuance to nearly 50 bln pounds - Aon (Adds reaction, background on the scheme)

By Kate Holton and Simon Jessop

LONDON, July 4 (Reuters) - The trustees of BT Group Plc's pension scheme have taken out insurance against the costs associated with members living longer than expected, in the biggest such deal of its kind in Britain.

BT, a former state telecoms group, has 320,000 members in its scheme, making it the country's largest private sector defined-benefit pension plan, which requires annual top ups from the parent company.

The trustees said on Friday they had created their own insurance company with the Prudential Insurance Co of America that would cover 25 percent of the scheme's total exposure to people living longer, or 16 billion pounds ($27 billion) of the scheme's liabilities.

Chairman of the Trustees Paul Spencer said in a statement the deal was groundbreaking in terms of size and structure.

The risk that some pension schemes would be unable to meet their obligations to pensioners has become particularly acute as people live longer.

The International Monetary Fund estimates that for each extra year of life expectancy, current liabilities in a typical defined benefit pension scheme increase by 3 to 4 percent.

That means companies may have to find billions of extra pounds and carry the risk of making a mistake in their calculations on their balance sheet.

But a so-called longevity swap - such as BT's deal - helps to insure against that risk. Under these schemes, a pension fund makes regular payments to a third party, typically an insurer, reinsurer or investment bank, based on agreed expected mortality rates among the scheme's policy holders.

The third party then agrees to take on the risk that those figures were underestimated and is liable to pay out to policy holders based on actual mortality rates.

British companies have led the way in setting up such deals. Insurer Aviva in March this year agreed to transfer the risk of members of its staff pension scheme living longer than expected to three reinsurers.

Deals done since the first one by engineering contractor Babcock in May 2009 total nearly 32 billion pounds. That figure has grown by half as much again as a result of the BT deal, data from consultants Aon Hewitt showed.

And more deals are expected.

Matt Wilmington, partner at Aon Hewitt, which advised on the deal, said: "We have been talking for a number of months about the increasing capacity and appetite of the global reinsurance market to take on pension fund longevity risk.

"2014 has already been a record year for risk settlement transaction volume and we expect a number of further transactions to add to the growing list of those completed."

BT said at the end of March its pension scheme had liabilities of 46.7 billion pounds and assets of 40 billion pounds. The company said the deal would not affect how much it pays into the scheme, although that is likely to increase when the latest review is completed, which is expected to be next year.

BT currently pays annual deficit payments of 325 million pounds and analysts believe this could increase to nearer 500 million pounds following the next review. The triennial review began on June 30 and often takes around 9 months.

($1 = 0.5877 British Pounds) (Editing by James Davey and Jane Merriman)