First Longevity Experience Option to be traded by Deutsche Bank by year-end

As it attempts to kick-start a liquid market in longevity risk, Deutsche Bank is set to perform the first trade of a new longevity risk transfer instrument, which it calls the Longevity Experience Option (LEO), by the end of this year according to a report.

A report in International Financing Review discusses the new product and its goal of bringing a standardised longevity risk transfer to market to help pension funds cost-effectively hedge their exposure to aging populations.

The Longevity Experience Option is a ‘tradable call spread on longevity’, according to the report, and Deutsche Bank is apparently set to trade the first contract by the end of this year. The LEO is designed to complement customised longevity hedging solutions, which are often too complex or expensive for smaller pension funds, and is designed to be quicker to set up and put in place than more costly hedging methods.

Being named as the ‘Longevity Experience Option’ certainly gives the impression that the hedge will be based on the longevity experience of specific cohorts from a pension fund, allowing the pension funds managers to transfer the risk of specified shifts in the longevity of the cohort, baselined against an index.

According to the IFRE, the LEO is; “Structured as out of the money options struck on a 10-year forward basis, the over-the-counter instruments will be traded under a standard ISDA agreement.” The longevity options will reference longevity benchmarks from the Life and Longevity Markets Association, which were published in June using 2012 data for England, Wales and the Netherlands. The contracts can be further customised by targeting specific cohorts of pensioners, in five-year groupings from age 50 to 79.

The LEO contracts will have a ten-year duration, which Deutsche Bank believe to be the best fit for both buyers and sellers of such instruments. The length of a longevity risk transfer contract has been one of the issues to hinder the market as investors do not want such long duration assets, particularly where there has been little liquidity.

From the article it seems that Deutsche Bank are aiming to open up more regular trading in longevity risk with this product, but do not expect it to replace the larger, customised swaps and hedges which provide cover more closely matched to the pensioner involved. Basis risk will exist in these contracts but they will provide a valuable and more accessible form of risk transfer, which if issuers and investors accept the basis risk could see traction.

Paul Puleo, who heads up pensions and insurance risk markets at Deutsche Bank, explained; “By bringing capital markets capacity to bear and structuring the contract properly, you can create an ecosystem of risk solution providers and enhance future capacity.”

The Longevity Experience Option (LEO) could be an extremely interesting risk transfer tool in the longevity space and it will be fascinating to see how readily the first trade is accepted by the capital markets when it launches later this year. Other efforts to create index-based options or swaps for longevity risk transfer have so far failed to gain any traction.

Puleo commented; “This will be the development that creates the next version of bespoke, which is less bespoke. Whatever the solution to the problem ultimately becomes in the long run, this is a development that will play a significant role in leading the way.”

Deutsche Bank is clearly convinced that the LEO is what a market in longevity risk needs right now. It may not be the answer to creating a market in longevity risk but Deutsche believes it is a step in the right direction. It will be interesting to see if it is right and we will update you when or if we hear more about the Longevity Experience Option.