Abstract
This paper updates Living with Mortality published in 2006. It describes how the longevity risk transfer market has developed over the intervening period, and, in particular, how insurance-based solutions – buy-outs, buy-ins and longevity insurance – have triumphed over capital markets solutions that were expected to dominate at the time. Some capital markets solutions – longevity-spread bonds, longevity swaps, q-forwards, and tail-risk protection – have come to market, but the volume of business has been disappointingly low. The reason for this is that when market participants compare the index-based solutions of the capital markets with the customized solutions of insurance companies in terms of basis risk, credit risk, regulatory capital, collateral, and liquidity, the former perform on balance less favourably despite a lower potential cost. We discuss the importance of stochastic mortality models for forecasting future longevity and examine some applications of these models, e.g., determining the longevity risk premium and estimating regulatory capital relief. The longevity risk transfer market is now beginning to recognize that there is insufficient capacity in the insurance and reinsurance industries to deal fully with demand and new solutions for attracting capital markets investors are now being examined – such as longevity-linked securities and reinsurance sidecars.
Highlights
Consultancies tend to have fairly streamlined processes for running off stochastic projections in order to illustrate the magnitude of each element of the longevity risk; these would typically be based on simplified pension benefits but would reflect the most important aspects of the scheme, such as membership age, gender, and pension amounts
With investors increasingly monitoring the size of defined benefit (DB) liabilities and the effects on company share prices, profits and dividends, the International Monetary Fund (IMF) said offloading these liabilities to insurers “is an attractive option” and “may represent a market-efficient arrangement” and that “regulation could play an important role in this area by facilitating such transactions.”
It becomes painfully obvious that vast sums of additional risk capital must be dedicated to adequately managing longevity risk
Summary
A little over a decade ago, the longevity risk transfer market started. This is a global market, but it began in the UK in 2006. Swiss Re pioneered the successful issuance of a longevity-spread bond, known as Kortis, but again the size of the issue was small. The demand for the capital market solutions that have been proposed for hedging longevity risk has been disappointingly low. Pension plan trustees, sponsors and advisers preferred dealing with risk by means of insurance contracts which fully removed the risk concerned and were not yet comfortable with capital market hedges that left some residual basis risk
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