Risk Management Solutions (RMS) have announced that they conducted mortality and longevity risk analysis for the recently completed €12 billion longevity swap involving Aegon and Deutsche Bank. As we wrote on Friday here, the record-breaking longevity risk transfer transaction saw Aegon offload €12 billion of their Netherlands longevity risk to Deutsche Bank, who in turn transferred the risk to capital market investors. The announcement from RMS provides some more detail on the modelling underlying the transaction.
RMS conducted a mortality risk analysis of the Dutch population to help capital markets investors assessing the transaction to quantify Dutch longevity risk. The analysis looked at estimates of lifestyle trend changes, medical advances and future health care environments specific to the Dutch population. RMS says that previous longevity models for the Netherlands failed to look at future medical advancements and the impact they could have on mortality improvements so their analysis uses “cause of improvement” modeling for probabilistic longevity scenario generation.
The Netherlands population presents some specific challenges for modeling future mortality improvement scenarios. It has experienced high mortality improvement rates over the past decade, with up to 4% annual improvement rates across retired ages. The Netherlands has higher smoking rates than other European countries, but slightly fewer deaths from cardiovascular disease. It has lower obesity levels, higher standards of health care, and a marked birth cohort effect around the birth year of 1936, some six years later than the similar cohort effect in United Kingdom.
The need for longevity risk protection results from uncertainty around the future life spans of retired men and women drawing pension benefits. Pension funds, annuity providers, and insurers are increasingly looking to protect themselves from potential funding shortfalls. Longevity risk transfer to the capital markets has proven difficult in the past because of investor reluctance to accept the major uncertainties inherent in longevity risk. Detailed analysis of medical improvement scenarios provided by RMS modeling underpins investor confidence in risk assessments.
In 2010, the increasing levels of mortality improvements seen earlier in the decade were reflected in a major revision of actuarial tables by the Dutch Actuarial Society, which caused a significant increase in liabilities for many pension funds. This results in an increasing demand for longevity protection in the Netherlands.
The RMS approach to longevity risk modeling is more transparent than a statistical model, and is rapidly gaining acceptance within the pension and annuity markets. Traditional approaches involve extrapolation of historical mortality rate volatility out into the future. The RMS model begins with current mortality levels and trends, and then explores scenarios for future trends in the different causes of mortality improvement, incorporating likely timelines for medical developments that are currently in the lab or new drugs at different stages of approval processes.
Risk Management Solutions now has longevity risk models for the United Kingdom, the United States, Canada, the Netherlands, France, and Germany. A growing number of clients are using RMS models to inform their internal model applications and capital management strategies for Solvency II.
“There are very interesting, different local market conditions for the variation in longevity risk from country to country,” said Andrew Coburn, senior vice president of LifeRisks at RMS. “Demographics, social structures, and lifestyle patterns are very different in each country, and the national health care systems result in some very different health outcomes for local populations. These need careful adaptation to model life expectancy projections in each territory.”
“Longevity is one of the most difficult risks to take to market,” said Peter Nakada, managing director of RiskMarkets at RMS. “There is clearly strong demand for longevity de-risking solutions, but there is such a wide spread of opinion and disparity of expectations around the appropriate pricing. We believe that RMS can help facilitate the growth of this market by providing an objective, verifiable benchmark assessment of the risk that has the respect of investors.”
RMS has previously used its longevity models to support de-risking transactions in other territories, including the Kortis bond in 2010 for Swiss Re which protects against mortality divergence in the U.S. and U.K. Other RMS mortality causal models include pandemic, terrorism, and natural catastrophes and have been used to support excess mortality capital markets transactions, including the VITA series of mortality bonds for Swiss Re.
The success of this record sized longevity risk transaction could stimulate other sponsors to try to replicate the deal. Many potential sponsors have been waiting for a deal to prove the appetite of investors to assume longevity risks, this deal certainly does that. We could see a number of these type of longevity swap deals this year.