Reinsurer Swiss Re has renewed calls for a liquid market for longevity risk transfer to be created in their latest publication. With recent estimates suggesting that the average pension fund is already underfunded by 24%, life expectancy increasing globally and over $20 trillion of defined benefit assets exposed to longevity risk, Swiss Re insists that the capital markets is the only source of capital and capacity large enough to support the world’s longevity risk transfer needs.
“A capital market could be vital for the insurance industry in the long term,” explains Alison Martin, Head of Life & Health Reinsurance at Swiss Re. “As the scale of the risk is so vast, capacity is unlikely to meet the future demand for longevity risk solutions without the involvement of the capital markets.
As life expectancy increases, ensuring that people can leave work with sufficient financial security to enjoy their retirement years is one of the biggest financial challenges that society faces today, says Swiss Re. Reinsurers and insurers play a leading role in this, for both pension funds and individuals, helping to offset the risk through products like longevity insurance, longevity swaps and annuities. However reinsurer and insurer capital alone is by no means sufficient to address the growing size of the longevity risk problem, meaning that there is a growing need for ways to extend re/insurance industry capacity. The most obvious source of additional capacity which could support re/insurers in the transfer of longevity risk is the global capital markets.
Swiss Re’s report, A mature market: Building a capital market for longevity risk, explores the questions being posed by investors, pension funds, insurers and regulators. Who would participate in a longevity capital market? How would a market be profitable for investors? What would be the function of longevity risk in an investor’s portfolio? What is the role of policy-makers and governments in such a market? Would pension funds access the market directly?
The report features a number of case studies and highlights the lessons learned by successful capital markets, such as the UK inflation market and the insurance-linked securities market. It also looks at the one successful example transaction where longevity risk was securitized and transferred to capital market investors, the Swiss Re ILS deal Kortis Capital Ltd.
Swiss Re highlight the importance of a broad range of investors to support a liquid capital market in longevity risk. This market would need to have secondary trading features to allow investors to offload or buy into the risk at any point in time. Investor education is key to increase comfort levels in the understanding of longevity risk as an asset class. This will also help the market come to better informed decisions about premiums, both from the investor point of view of how much they are prepared to accept to take on longevity risk, as well as for the issuers view of how much they are willing to pay.
The publication also contains some interviews with potential investors, who have differing opinions over the extent to which a liquid market in longevity risk is feasible. Concerns cited include pricing considerations, the role of regulations and rating agencies as well as the level of education in the market.
“A liquid market would form a part of an overall solution,” concludes Martin, “and we must work together as an industry, as well as with other stakeholders in society, to create a system that is sustainable throughout people’s longer lives.”
Swiss Re suggests that indemnity solutions will be key and that pension funds, which are often small, should offload their longevity risks to insurers and reinsurers rather than directly to the capital markets. This would allow pension funds to remove longevity risk from their balance sheets completely and pass it onto re/insurers using indemnity solutions.
The re/insurance industry seems to be the natural home for longevity risk, says the report, so re/insurers should accumulate the risk through providing indemnity solutions to pension funds. The capital market should then offer a risk sharing or risk transfer solution to re/insurers, thereby increasing capacity for longevity risk and allowing re/insurers to continue taking on the risk. In this way the ILS markets provide a good model for how this could work.
Swiss Re sum up their thoughts in a succinct paragraph at the start of the publication:
A capital market for longevity risk could help address the challenges of funding longer lives. An increased awareness of this risk, the frequent and consistent publication of data, along with the establishment of a liquid secondary market, are all key factors to consider. A market would form part of an overall solution involving the co-operation and innovation of the public and private sectors to ensure that we continue benefitting from our ageing societies.
They also highlight that this is not something that can be solved quickly and finding a long-term solution to longevity risk requires input from a broad cross section of society:
Capital markets are important to develop, but they are only part of the system involved in addressing the financial issues arising from people living longer than expected. Any solution would include governments, employers, re/insurers and the wider financial services industry working together to create a sustainable model that would last long into the future.
You can access Swiss Re’s publication here.
Certainly one of the most important issues is investor education on longevity risk as an asset class. In our conversations with investors they express uncertainty over the types of instruments that might be used to transfer the risk, with many stating they’d like to see longevity bond issuances as they are familiar with securitization and the secondary market aspects of it. Other investors are confused about how this type of risk can be priced and how pricing could be influenced over time. Some investors we’ve spoken with currently find just the idea of how you could invest in longevity risk difficult to understand. There is clearly work to do.
We’ve written about the need for a capital market solution to longevity risk a number of times in recent years. A few of our articles on this subject can be found below.