Demand from life insurance and reinsurance firms will drive continued growth and also global expansion of the market for pension longevity risk transfer and swaps, according to a report from Prudential Financial, Inc.
Insurers and reinsurers are “motivated” to assume increasing amounts of longevity risk, through longevity swap and reinsurance transactions, according to Prudential. This motivation derives from the need and desire to balance mortality and longevity risks, as well as to expand globally.
For life insurance and reinsurance players who assume large amounts of mortality risk from selling life policies and assuming portfolios of life risk, underwriting pure longevity risk is seen as a natural hedge, balancing the mortality exposure and enabling them to write more of each.
Secondary motivations include the desire to expand and diversify across industries, regions and socio-economic groups, which again longevity risk can play a useful role in.
There is ample capacity in the global reinsurance market for longevity risk, Prudential explains, driven by the motivations above. There is also likely a factor driving interest in longevity risk, as it has not been affected as a sector by the growth of alternative capital and insurance-linked securities (ILS), as longevity risk has not become a major part of the alternative market to date.
Amy Kessler, senior vice president and head of Longevity Risk Transfer for Prudential Retirement’s Pension Risk Transfer business, commented; “We expect to see this trend continue to grow because this is a sensible profitable business for life companies to write for all the right economic reasons.”
Kessler believes that the success and growth of the longevity risk transfer market in the UK is set to be repeated in the U.S. and elsewhere in the world, with drivers now pushing pension funds globally to begin to look more seriously at longevity exposures.
“There is a strong trend toward the globalization of the annuity and longevity reinsurance market that is being driven by the de-risking of corporate pension funds in many countries. U.K. advances in pension risk transfer are being emulated in the U.S. and Canada and are rapidly spreading to countries with significant defined benefit pension plans,” Kessler explained.
The UK market is the leader in longevity risk transfer and reinsurance transactions to date, with both pension funds and insurers tapping into the ample reinsurance capacity available to transfer risks to.
In total across all pension risk transfer and de-risking deals, the UK has seen approximately $180 billion in liabilities transferred from 2007 to June 2015. The UK also leads the way in terms of transaction structure and product innovation, according to Prudential.
But the U.S. and Canadian pension plan sponsors have been watching closely and there is an expectation that both regions will accelerate their use of pension risk transfer strategies, with longevity risk transfer expected to make up a sizable portion.
The chart above shows the rapid growth of the pension and longevity risk transfer market in the UK. If the U.S. and Canada adopts longevity hedging to a similar degree a significant amount of reinsurance capacity could be required to absorb this risk.
Prudential says that when it looks to the how the UK market’s developed; “We see the global future of pension de-risking and the shape of the risk transfer market to come to other countries.”
Longevity risk transfer is particularly flourishing for pension plans which have been frozen by corporations, a trend that the UK saw explode in the last ten years. This has resulted in innovation in longevity risk transfer structures for UK pensions.
Prudential says that this innovation and the resulting risk transfer strategies that have emerged; “Promise to become the dominant path for large, sophisticated pension funds worldwide seeking to hibernate pension risk on their balance sheet with a longevity hedge in place.”
“Longevity risk remains an important yet often-ignored risk that cannot be managed through investment strategy alone,” Prudential warns.
While longevity risk has historically not been front of mind for U.S. pension fund sponsors, Prudential expects this to change as the emerging emphasis on longevity tables builds momentum. As a result “an opportunity exists to include longevity risk in the greater pension risk discussion” Prudential explains.
Prudential also warns that; “Pension decisions made without longevity risk in the equation will consistently undervalue the benefits of risk management or risk transfer.”
As longevity risk transfer increasingly becomes part of the pension de-risking conversation, the end result will be a greater need for capacity to absorb this risk. While the world’s life insurers and reinsurers are capable of absorbing the longevity risk hedged today, should the U.S. come on-line meaningfully there may be an opportunity for capital market solutions to come to the fore.
The captive transactions which have become so popular for large pension funds looking to enter more directly into longevity swaps and reinsurance, without the need for an intermediary, could perhaps find the capital markets as a counterparty in years to come, as the volume of longevity reinsurance capacity required continues to grow.