Reinsurers cannot solve scale of longevity risk challenge

Recent longevity swap deals, such as the recent Swiss Re deal with insurer LV=, demonstrate a need for these solutions and reinsurers will be likely to play a growing role in absorbing longevity risk.

But some question the capacity of the insurance industry to deal with this risk and the extent to which this risk management tool is a priority for insurers and pension funds.

Eva-Maria Keller, product manager of longevity, market data and analytics at Deutsche Börse, points out that reinsurers only have a finite amount of capacity to offer. Ultimately, only the capital markets have the capacity to deal with the scale of this liability long term.

“We strongly believe that a capital market for longevity risk is required to cover worldwide exposures and Deutsche Börse is committed to providing data and risk benchmarks to make longevity risk become tradable,” she said.

She says that standardising such transactions will be important in developing this as a new asset class. The more standardised the market becomes, the better the chance that a liquid market develops – something that is essential when dealing with maturities of 10 years and longer, according to Keller.

“Common market benchmarks like standardised longevity indices create the necessary level of transparency to overcome information asynchronies of longevity risk sellers and buyers,” she said. “Unfortunately, we are still waiting for the first real index-based transaction with published prices to stimulate a transparent market for longevity risk transfer.”

Others agree that the capital markets must play an important role in future deals. Wolfgang Murmann, vice president of corporates and markets, pensions and insurance structuring at Commerzbank, believes that reinsurers will be further hampered in their ability to take on such risks by accountancy changes that will require them to de-risk further. But they could still take positions between the client and the financial markets.

“Corporates will seek indemnity-based hedging of pure longevity risk from their defined benefit corporate pension schemes to insurers and reinsurers,” he said. “Insurers and reinsurers will then hedge aggregate longevity risk through indices to the capital markets, while retaining the basis risk between the indemnity hedge and the index.”

Governments can help to further develop this market through the issue of longevity-linkers, allowing them to manage their longevity exposure, together with providing a yield term-structure for the markets, according to Murmann.

But Henry Kus, chief executive officer and co-founder of Traymar Capital, a specialist insurance-linked securities investment manager, has a different take on the development of this market. He points out that longevity risk is not the biggest risk or challenge that pension funds must grapple with and suggests that only organisations extremely confident the investment side of their business is in order will consider doing these deals.

“Depending on their investment strategy perhaps longevity is a second or maybe a third order risk,” he said. “Perhaps those looking to enter into longevity swaps have buttoned down the asset side of the equation. Presumably LV can get their head around a fair value for the swap and Swiss Re cut them a good deal. Or maybe it was vanity!”

Richard Farr, the head of actuarial service group for BDO’s UK pension advisory practice and former head of Swiss Re’s pension practice, adds that the use of longevity risk mitigation products are more “in vogue” since a widespread failure to produce desired investment returns.

“Everywhere you look, from the US government to other state-sponsored healthcare systems, people are seeing the public outcry that part of the social safety-net is at significant risk. As a result, the growing recognition that global longevity risk exposures are escalating will generate the increasing need for new solutions to manage this exposure. The post war dream of the provision of affordable long term care and pensions for all, like the Titanic, could be holed by the iceberg of longevity.”