Capital market for longevity risk the latest trend?

A new report by Swiss Re pushes the idea of a liquid capital market in longevity risk that can help pay for people who are living longer.

The report, “A mature market: Building a capital market for longevity risk” addresses many questions posed by investors, regulators and pension funds about whether a longevity capital market is viable and how such a market might work.

As life expectancy around the world continues to rise, many people won’t have enough money to have a financially secure retirement. Reinsurers and insurers are playing a lead role for both pension funds and individuals in helping them to shoulder the risk through products such as longevity insurance, or longevity swaps, and annuities. According to the report, many pension funds are underfunded and there are more than $20 trillion in defined benefit assets that will be exposed to longevity risk globally.

So, the need exists to find ways to extend insurance industry capacity and ensure a sustainable funding system for longer lives.

"A capital market for longevity risk will be vital for the insurance industry in the long term," explains Alison Martin, head of Life & Health Reinsurance at Swiss Re. "As the scale of the risk is so vast, capacity is unlikely to meet the future demand for longevity products without a capital market."

Developing longevity capital markets would involve creating instruments allowing a seller of longevity risk to pay a premium, or coupon, to investors and, in return, investors would assume the risk of losing some, or all, of their investment if future improvements in life expectancy are higher than a pre-agreed rate, the report found. One example of this would be a longevity bond in which a US$100 million investment in a longevity bond would allow the investor to receive those funds back in addition to earned coupons upon retirement or the investor would lose part or all of their investment, particularly if life expectancy improves beyond a pre-determined level.

Swiss Re's report explores the questions being posed by investors, pension funds, insurers and regulators. Who would participate in a longevity capital market? How would a market be profitable for investors? What would be the function of longevity risk in an investor's portfolio? What is the role of policy-makers and governments in such a market? Would pension funds access the market directly?

A mature market draws on the lessons learned from established capital markets, such as the UK inflation market and insurance-linked securities markets, as well as a previous successful longevity capital market transaction. These examples provide insight into the opportunities and pitfalls in building investor trust in a potential longevity market.

The study also contains interviews with potential investors who have differing opinions over the extent to which a longevity market is a realistic vision. Their concerns include general pricing considerations, the role of regulators and rating agencies, and the level of education in the market.

Martin concludes: "A liquid market would form part of an overall solution. We will work together with other stakeholders in society to create a system that is sustainable throughout people's longer lives."

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