The fact that we are living longer is not new, but over the course of the last two decades it has become increasingly apparent that recognising, quantifying and managing longevity risk is a crucial issue for pension funds and insurers.
“We are getting more interest in this but it’s still a strange asset class. People are familiar with commodities and even familiar with cat risk, but I think the barrier is the maturity of the asset class; that’s the issue we haven’t quite resolved.”
David Blake
Over the past 170 years, wealthy countries have seen life expectancy almost double. In 1840, women in Sweden had the highest known life expectancy, at 45 years. That figure is now comfortably outstripped by Japanese women, who can expect to live to the ripe old age of 86. Life expectancy beyond the age of 65 has also been steadily rising – at about four to five hours per day in developed countries.
If these improvements continue – and there is little reason to suggest they won’t – most children born in countries with high life expectancy over the last 15 years will live to celebrate their 100th birthday.
The rising awareness of improving mortality rates has led to a range of products and strategies to help hedge against longevity risk, with pension funds using buy-ins and longevity swaps to tackle the problem.
As longevity improves and the subsequent demand for hedging against that risk grows however, the issue of capacity becomes an issue. Insurers and reinsurers are only willing to take on so much of this risk in order to remain healthily diversified. Furthermore, the introduction of Solvency II legislation inJanuary 2016 will make things even harder. The issue of coming up with a new solution for transferring that risk has lead many in the industry to conclude that capital markets could provide the necessary demand and scale.
They believe longevity could be treated as a market like any other, with a supply side, a demand side and manufacturers in between.
In this framework, longevity risk could be treated as a raw material sourced from pension plans and annuity providers on the supply side.
In the centre of the market sit re-insurers and investment banks, which can fill the role of manufacturers, turning the raw materials into a product that investors on the demand side of the market wish to purchase.
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