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LONDON—Rolls Royce P.L.C. has entered into a £3 billion ($4.63 billion) longevity swap with Deutsche Bank A.G. to reduce the risk on some of the liabilities of its defined benefit pension plan.
Under the agreement, one of the largest of its kind, Deutsche Bank will hedge the longevity exposures of the plan by passing the risk on to a syndicate of reinsurers, the bank said in a statement.
The deal covers about 37,000 pensioners and reduces the risk on approximately £3 billion of Rolls Royce's nearly £7 billion ($10.81 billion) U.K. pension liabilities.
Under the terms of the deal, Rolls Royce and Frankfurt, Germany-based Deutsche Bank have agreed on an average life expectancy for plan members, London-based power systems company Rolls Royce said in a statement Monday.
If plan members live longer than expected, the bank will make payments to the plan to offset the additional pension costs, it said. If plan members live for a shorter time than expected, the plan will make payments to the bank.
The arrangement allows future liabilities to be predicted with greater certainty, Rolls Royce said.
The cost of the transaction, which was not disclosed, will be borne by the pension plan but will have no material affect on its funding arrangements, Rolls Royce said.
“This is the latest in a series of measures we have taken to achieve greater certainty for our future funding requirements,” Andrew Shilston, finance director of Rolls Royce, said in the statement.
“We have been working closely with Rolls Royce for some years to enhance the security of all our members' benefits. This is another important step forward,” said Paul Spencer, chairman of the board of trustees of the plan.
Aon Hewitt was the lead adviser to the trustees.
“We worked closely with the trustees to decide that this was the right approach for them to take and also that the swap was structured in a way that offered the best possible terms on price, security and other key longevity features,” said Martin Bird, a managing principal at Aon Hewitt in London, in a statement.
Mercer L.L.C. in London was investment adviser to the trustees and London law firm Linklaters L.L.P. was legal adviser to the trustees.
Fitch Ratings Ltd. In London said the longevity swap was an important step in managing one of the key risks facing occupational pension plans.
In a statement, Fitch said the deal, which is does not expect to affect Rolls Royce’s A- rating, is “one of a handful of transactions so far in a market that is expected to grow.”
Longevity risk represents long- and short-term risks to pension plans, Fitch said.
“The long-term effect is obvious—the longer pensioners live, the more has to be paid to them,” it said. “The short-term risk arises from the revaluation of pension liabilities as evidence grows that assumptions need to be changed,” it said.
Over the past five years, most companies have built assumptions of longer life expectancy into their pension plans, which causes a one-off increase in liabilities, Fitch noted.
“Under the United Kingdom’s existing regulatory system, such increases lead to higher funding requirements in the short to medium term,” Fitch explained.
The rating agency said that while longevity swaps can negate increases in plan deficits, the mechanisms are not cheap.