Swiss Re Insurance-Linked Fund Management

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A capital market for longevity risk transfer is not far away


Artemis attended the 6th Annual European Insurance-Linked Securities Conference, held by rating agency Standard & Poor’s in London, earlier today to hear what the speakers had to say about the market. One of the panels was particularly timely as it discussed the potential for further development of the longevity risk transfer market and asked the panelists to give their view points on how far along the market is, what is required to progress its development and when we could expect to see some transactions.

The topic is timely as it comes hot on the heels of Swiss Re’s new report looking into the longevity market and discussing the need for a liquid capital market to support it. The panel all echoed Swiss Re’s call that capital market investors are needed to support the transfer of longevity risk, given the huge and growing nature of the exposure. However they were positive on the developments and insistent that a market for longevity risk may not be that far off. Here are the key points that we managed to glean from the panelists.

The panelists were all in agreement that the longevity market, as it stands currently, is still in a nascent form and development is ongoing. They said it takes time to create solutions that will work for sponsors and investors alike and which truly do transfer the longevity risk from one party to another.

Jeff Mullholland, Managing Director at SG Americas Securities, LLC, a division of Societe Generale, was vocal on this topic. He explained that getting the development of a longevity risk market right is important and it is vital that mistakes which perhaps slowed the development of markets such as catastrophe bonds and ILS were not repeated. He likened the current state of the longevity risk market to the cat bond market in 1997, stressing that we mustn’t make the same mistakes that were made with ILS in the early days.

Mulholland said that the hard part is getting things right for the sponsors, be they insurers or reinsurers. A positive he notes is the appetite that Societe Generale have seen from capital market investors, who have expressed a desire to take on exposure to longevity risk if the price, and payment, was right. Mulholland was fairly bullish on this, stating that he was pleasantly surprised by the availability of capital for this risk, saying that investors were keen for the return it could offer and the diversification. He said that he see’s a mature longevity risk market taking a number of forms as there is appetite for rated notes (perhaps in cat bond or ILS form, similar to the Kortis Capital transaction), OTC swap type transactions as well as collateralized reinsurance solutions. That’s encouraging as it shows that people aren’t focusing on a single solution to the problem and a variety of instruments are being considered, much like has now emerged with natural catastrophe risks.

Mulholland was adamant that it is vital that a capital market for longevity risk develops with transparency as a key factor, that standardisation is promoted, particularly in terms of documentation and structures and that the market has true liquidity. He stressed that banks shoulder much of the responsibility to ensure these aims are achieved. In terms of liquidity, he said that the aim should be to achieve more liquidity than the ILS and cat bond market has.

Another panelist, Cord-Roland Rinke, Managing Director Life and Longevity at Hannover Re, said that one of the issues the longevity market has faced to date is price, as reinsurance deals have tended to be cheaper. Other considerations he raised include the time to execute, deals done to date have taken months or even over a year, and this has helped to drive sponsors towards reinsurance. Ensuring that there is total risk transfer is also important, Rinke said, adding it is vital that all the risks are taken on as in reinsurance.

Rinke said that the potential for a capital market for longevity risk lies in the longevity trend risk that reinsurers tend to accumulate, and this is where the ILS market can step in with capital market investors, he felt. Rinke also stressed the importance of liquidity in a longevity market as investors must be able to get out of deals as easily as it is to get into them.

Another panelist came from an insurer who has been involved in pension risk transfer deals. Chris Madsen, Head of Risk Structuring and Transfer at AEGON NV, was keen to stress that there would likely be a pipeline of longevity risk, from insurers, to reinsurers and then onto a capital market for longevity risk. So it will likely be retrocessional type deals that are the first to transact and be publicised.

Marcel Grandi, Head of Underwriting Insurance-Linked Strategies at Credit Suisse Asset Management, said that there are not enough reinsurance players in the longevity market meaning that risk transfer capacity is lacking and so the capital markets are a natural fit for the risk. So far he said that he is aware of just a few illiquid, private deals, but that he has big hopes that a liquid market in longevity risk will develop.

Back to Jeff Mulholland of Societe Generale, who said on the topic of deal terms and time to maturity, that he felt maturity of transactions was not an issue and that 15 year deals were a possibility.

Here there was some disagreement and Cord-Roland Rinke of Hannover Re said that he felt 15 years was likely not enough, citing an example of a 65 year old pensioner who would likely still be alive 15 years later at 80. He said that maturity needs to be more than 15 years to enable a real hedge. Because of the possible duration of deals more liquidity than the cat bond market is needed, Rinke said, in order for investors to be happy to commit capital.

Jeff Mulholland drew more analogies between the longevity market as it stands today, with the cat bond market in the mid 1990’s and said that banks need to be careful not to make the same mistakes. Again he stressed the importance of transparency and standardisation of documentation. Interestingly, he said that Societe Generale would likely be happy to share its internal pricing models with clients, in the interests of transparency, if it would help to kick start a market in longevity risks. Mulholland said that he believes the market will see some activity before the end of this year, or at the start of 2013, alluding to the possibility of a pipeline already forming, which is encouraging. He finished by saying that minimising the tail exposure might be helped through the use of commutation payments and he said he is convinced that hedges can be developed that reinsurers, the natural accumulators of longevity risk, would be happy with.

The panel as whole agreed that modelling is vital to the development of a market in longevity risk. The RMS model was cited as one that the market was ready to accept, but longevity risk is harder to model than catastrophe risks and a multiple model view is required. There could be an opportunity here for a modelling firm to produce something that would provide an alternate viewpoint.

Deal structures need to be simple, said the panelists, particularly to start with so that investors can easily understand them. Index based transactions are a likely starting point. Most of the panelists agreed that it is likely that at least half of the longevity deals which come to market over the next year will be in the style of a cat bond. This is likely as it will help investors to understand them and be easier for existing ILS investors to match them with their portfolio.

The panelists were in agreement that it would insurers and reinsurers who would drive the development of a capital market for longevity risk, particularly reinsurers hedging the extreme longevity trend risks from the right-hand of the tail. Reinsurers will be the likely sponsors, in similar fashion to the early cat bond market. Most agreed that Europe is likely to lead on this, but that the U.S. was speeding up and wouldn’t be far behind.

Overall the session was extremely positive and almost bullish on the development of a liquid capital market for transferring longevity risk. With comments strongly suggesting that we might see a transaction in the coming months, it will be interesting to see whether that is in a cat bond or ILS format, similar to Kortis, or whether it takes the form of a swap. Whatever form it comes in the panelists were all positive that a capital market for longevity risk transfer is not far away.

Our thanks to Standard & Poor’s for inviting us to a very informative event.

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