Babcock deal kicks off corporate longevity hedging

* Watson Wyatt working on swaps deals covering 10 bln pounds

* Market growth to depend on buy-out providers' acceptance

By Cecilia Valente

LONDON, May 12 (Reuters) - A deal allowing Babcock International (BAB.L) to hedge exposure to improving life expectancy opens the door to an industry that will protect pension schemes worth billions of pounds against longevity risk, advisers said.

The British engineer's adviser, Watson Wyatt (WW.N), told Reuters on Tuesday it is advising on 10 longevity swap deals covering exposure of about 10 billion pounds ($15.17 billion).

Longevity swaps seek to hedge out the risk of retired workers living longer than had been expected and thereby placing an extra burden on the company pension scheme. The pension trustees pay a bank or other counterparty to take on some of the risk over a defined period, in Babcock's case 20 years.

The longevity swap market has been confined to a few over the counter deals between insurers and investment banks but engineering group Babcock has become the first major corporate pension scheme to embrace the technique with a deal to hedge 500 million pounds worth of longevity liabilities [ID:nLB600429].

The deal marks the first transaction involving a UK pension scheme and confirms speculation in the last few weeks that a deal was imminent.

"Longevity swaps, which do not normally require large transfers of capital at outset, may be a potential solution for a number of schemes," said Tiziana Perella, head of buyouts at Pension Capital Strategies - a subsidiary of Jardine Lloyd Thompson Group.

A longevity swap can be an alternative or the preliminary step to a full buyout, whereby the scheme offloads all its assets and liabilities to a third party.

Unlike buyouts, longevity swaps do not involve the transfer of pension assets and liabilities, and the payments are staggered over the period of the deal, making them a more accessible option.

Perella said longevity swaps are likely to appeal to large pension schemes, with deals over the next 12 months covering up to 2 billion pounds.

Jerome Melcer, partner at consulting firm Lane Clark & Peacock, said growth would depend on whether buyout firms decide they can take on schemes with longevity swaps in place.

"UK pension schemes are now moving towards full buyouts. It will be over decades, but the majority is now thinking they need to get rid of their schemes once and for all."

"The key test for longevity hedging markets is: can it work in that environment? Can longevity swap providers design their products so that a full buyout can take place with that swap in place, 10, 15 years down the line?" ($1=.6591 Pound) (Reporting by Cecilia Valente; Editing by Sharon Lindores)