By Sarah Hills

LONDON, Jan 31 (Reuters) -- A new association has formed to transfer longevity and mortality-related risk to the capital markets in the same way that some of the world's biggest perils, such as hurricanes and earthquakes, are protected against by shifting the risk to investors via catastrophe bonds.

The Life and Longevity Markets Association (LLMA), made up of a consortium of banks, insurers and pension experts, will develop a series of standardised indices that can be used as a global benchmark for trading longevity and mortality risk.

The risk will be traded as swap structures initially, but as the market develops, longevity bonds will be created to transfer the risk, much like transactions such as cat bonds in the insurance-linked securities (ILS) market and other large trend risks like interest rates and inflation.

Traditionally, longevity was owned by pension funds and transferred in the form of buy-ins and buy-outs to pension insurers, who then underwrite price specific pension fund risk. But the LLMA want to transfer the UK's 2 trillion pounds ($3.3 trillion) pension liability assets to the capital markets to help pension schemes and insurers manage the financial pressure of increased life expectancy.

Dramatic increases in life expectancy have left private sector pension funds and annuity providers with massive exposure to longevity, and there are few options currently available to hedge this risk on any significant scale within the private sector.

In the last three years, around 19.5 billion pounds of longevity risk has moved over from the pension funds to the pension insurers, which is a small amount compared to the total assets in the UK, John Fitzpatrick, a director of the LLMA and a partner at Pension Corp, told Reuters.

"The existing transactions between (re)insurers and the capital markets are relatively small. The association wants to build capacity in the capital markets and reinsurance sector in order to handle the likely increase in demand coming forward from longevity risk," he said.

"Longevity risk is a size that it should also go out to the capital markets."

In the next 20 years, the number of retirees is expected to increase by 60 percent, which will create a large financial risk to pension funds, governments and local authorities who run the schemes, said Fitzpatrick.

The ILS sector has been targeted due to its non-correlation to the performance of the broader fixed income market, which represents credit and market risk, according to the LLMA.

"Those investors already involved in the ILS market may already own the risk of lethal epidemics and life insurance, which are the mirror image of longevity risk and a natural hedge against mortality risk," said Fitzpatrick.

The LLMA will focus on pension-related longevity and mortality, rather than life settlements, and will look to increase its scope outside the UK as the initiate develops.

"The aim is to create a standardised product that the market can understand and trade. If we accomplish that, there will be more investors and more capacity to take on the risk from the pension funds, who are looking to reduce the largest risk they have in their portfolio, which is longevity," said Fitzpatrick.

The LLMA was established by AXA (AXAF.PA), Deutsche Bank (DBKGn.DE), J.P. Morgan, Legal & General (LGEN.L), Pension Corporation, Prudential (PRU.N), RBS (RBS.L) and Swiss Re RUKN.V.