Kortis bond laid foundation for longevity risk ILS market

The pioneering structure and model of Swiss Re’s 2010 Kortis Capital Ltd. longevity-linked insurance-linked securities (ILS) lays the foundation for successfully transferring longevity risks to the capital markets, according to research by the Pensions Institute at Cass Business School.

In a recent study, ‘Modelling longevity bonds: Analysing the Swiss Re Kortis Bond,’ Andrew Hunt and David Blake of the Cass Business School, City University London, discuss how the bond’s design can be replicated and expanded on to transfer longevity risks to the capital markets.

“The Kortis bond provides a new method of transferring extreme longevity risk from insurers and reinsurers to investors in the capital markets.

“As the prototype of a new breed of longevity-linked securities, it is important to be able to model and analyse it, so that the entire industry can learn and improve how to transfer these extreme risks more effectively and, so, better support the growing market for pension scheme de-risking,” said Professor David Blake, Director of the Pensions Institute and Co-author of the study.

The key, differing aspect of reinsurer Swiss Re’s Kortis bond is that it utilises the structure of a more typical catastrophe bond, and uses the variance in mortality rates from two different countries to determine whether the bond is triggered.

In the case of the Kortis deal this includes the divergence in mortality rates between the UK and the U.S., where Swiss Re reinsured pensions and annuities in both countries. Should mortality rates decline faster in the UK than in the U.S. then the investor loses their money, should this fail to happen then the investor receives their money plus a premium.

The deal transfers the longevity risk in relative terms and not absolute, “through the differential performance of different age-groups in different countries,” said Standard & Poor’s (S&P) credit analyst Paul Bradley in their press release about this deal at the time of its launch.

“The Kortis bond was designed to partially hedge this basis risk, so that sufficient divergence in mortality rates in the two populations would lead to a lower payoff on the bond, which offsets the adverse experience and higher reserve requirements faced by Swiss Re,” notes the report.

And, according to the study the unique design of the Kortis deal can, and should be replicated and exploited to bring a greater volume of longevity risk exposure capital to the ILS market.

Dr Hunt, Co-author of the report, said; “With the phenomenal growth of the pensions buy-out, buy-in and longevity swap market – almost $35bn in the UK alone (according to Towers Watson’s De-risking Report 2015) – there has been a huge transfer of longevity risk – the risk of faster than expected increases in life expectancy – to insurers and reinsurers. In turn, the reinsurance market has started to investigate novel methods for managing risks.”

Ultimately, notes the study, the success of transferring longevity risk to the reinsurance, catastrophe bond and ILS market depends on the willingness of the reinsurers to manage such an exposure.

But at times of persistent market stress, exacerbated by ample reinsurance capacity and heightened competition, any opportunity to diversify further will likely be welcomed by market participants.

The report examining the bond delves deep into the maths and science of its structure, design and potential use, which can be accessed in full here.

But the underlying message is that the Kortis deal should be duplicated and widely used to transfer longevity risks to the capital markets in an efficient and responsible manner.

The report notes; “We find that the design of the Kortis bond has many attractive features which could be used, developed and extended in the construction of other types of longevity bonds.”

Looking to the future the report calls for greater innovation and development of structures like the Kortis deal, as the need to re/insure and better-manage longevity risks increases with rising global populations.

And as the market evolves and the understanding and acceptance of these types of structured deals increases, the Kortis deal could be become the foundation for building an efficient longevity ILS market.