Divergent mortality rate improvements through socio-economic groups creates difficulties with the establishment of a market-based approach to longevity risk transfer, and could limit available reinsurance capacity for the risk, according to the 2016 OECD Business and Finance Outlook.
The Organisation for Economic Co-operation and Development (OECD) has highlighted potential hindrances with the creation of a market-based approach to longevity risk transfer, which could also reduce the availability of reinsurance protection for such risks.
The longevity reinsurance marketplace has reported impressive growth in recent times, as pension funds increasingly look to hedge the exposures of improved mortality rates and increased life expectancies in different regions, and reinsurers show a willingness to assume the risk.
However, according to the latest Business and Finance Outlook from the OECD, divergent life expectancy trends across socio-economic groups can complicate the ability of pension funds and annuity providers to measure and manage the risk.
“To the extent that the divergence of life expectancies for these groups relative to the lowest socio-economic groups continues in the future, mitigating the longevity risk for these populations could prove to be more expensive than anticipated, and could potentially result in limited reinsurance capacity for these risks.
“This divergence could also hinder the development of the market for longevity risk, as standardised longevity index-based instruments, which this market would require could prove to be less effective in mitigating the longevity risk for these populations,” said the OECD.
The OECD explains that for pension funds and annuity providers’ exposure to longevity risk fluctuates as a result of different trends across socio-economic groups, with a higher concentration of exposure occurring in higher socio-economic groups.
The OECD notes that there are substantial differences in life expectancies at age 65 for different socio-economic groups, influenced by a variety of factors including education attainment, occupation, and income.
Adding to the complexities is the fact that disparities across populations for all measures of socio-economic status, have increased over time for the majority of countries where data is available, says the OECD.
The availability of data also poses a problem for adequate mortality rate improvement assumptions, as for certain socio-economic groups a lack of sufficient data may not exist. Furthermore, where sufficient data is available, the OECD explains that measured improvements might not be factored into data sets.
Ultimately, the OECD stresses that divergent mortality rate improvements through different socio-economic groups that’s influenced by the previously mention drivers, makes it challenging for pension funds and annuity providers to establish appropriate mortality improvement assumptions – thus making it more difficult to adequately assess improvements.
“The increased risk of higher than assumed improvements implies that reinsurers will need to charge an adequate risk premium to accept this risk from pension funds or annuity providers,” says the OECD.
This could make reinsuring longevity risk for higher socio-economic groups much more expensive for pension funds and alike.
“If reinsurers are not able to diversify the longevity risk exposure that they are reinsuring, this could potentially lead to a capacity constraint for them to accept longevity risk from these segments of the population, further complicating the mitigation of this risk for annuity providers and pension funds,” says the OECD.
Should reinsurers take on more and more longevity risk it could reach a stage where it fails to diversify within their own capital models, which would mean they wouldn’t be able to take on more risk, resulting in the capacity constraint mentioned by the OECD.
However, with insurance-linked securities (ILS) markets and investors becoming increasingly sophisticated, capitalised, and able to assume a broad range of risks, large reinsurers could pass some of the risk to capital markets investors, enabling the ILS space to play a greater role here.
One benefit of this could be that the capital markets can become more directly involved in assuming longevity risk from pension funds and annuity providers, essentially becoming primary reinsurers of longevity exposure, as opposed to retrocessionaire to the reinsurers.
Furthermore, the OECD explores the notion of pension funds and alike passing the risk to the capital markets, but notes potential implications here.
“Passing the longevity risk to the capital markets could be an alternative solution for annuity providers and pension funds to access additional capacity for longevity risk. However, this would require transacting with index-based longevity instruments in order to address the needs of capital markets investors for transparency and flexibility in the transaction,” says the OECD.
To date, reinsurance companies appear more than willing and able to assume whatever longevity risk comes to the market, and industry observers and experts have noted an expectation that this will continue and intensify in the coming months.
As well as re/insurers being increasingly willing to take on longevity exposures, mechanisms to access sources of longevity risk are becoming more efficient, and the establishment of new; innovative mortality risk models will also assist the development of the market.
However, as discussed by the OECD divergent mortality rate improvements and life expectancies across socio-economic groups calls for innovative approaches to assessing improvements and achieving adequate, and sustainable longevity assumptions and pricing.
By targeting the influences of the differences in mortality rates and life expectancies by different socio-economic factors, the OECD feels a more sustainable, and improved longevity market can be achieved.