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The Actuary The magazine of the Institute & Faculty of Actuaries

An age-old problem

For a number of years there has been activity in the UK insurance market to hedge longevity exposures. This has spread more recently to the occupational pensions market. But the need to transfer these risks, and to whom they get transferred, goes wider than the UK. Swiss Re’s new report, A short guide to longer lives – longevity funding issues and potential solutions, aims to bring the longevity issue and debate to a wider, global audience.

The report highlights a substantial amount of longevity risk that has built up around the world and continues to accrue within state pension systems, occupational pension plans and annuity books. As the proportion of pensioners in the population grows globally, this will become increasingly difficult to sustain.

Re/insurers with a large portfolio of mortality risk and diversification across other lines are best placed to write and hold longevity risk in the current climate. This is demonstrated by the various pension plan longevity swap transactions announced in the UK.

In each of these, all — or the vast majority — of the longevity exposures written by the bank or insurer were immediately passed to third-party reinsurers or directly written by a reinsurance group.

Seeking long-term capacity
While there is substantial longevity capacity available from reinsurers, it is finite, it is dwarfed by accrued global exposures, and it will not be sufficient in the long term. As more and more longevity exposure holders seek to hedge their risks, current capacity will come under stress.

The capital markets offer potential capacity, as they may be able to bring investors, who want to access longevity as an asset class, together with the holders of longevity exposures. But this will only develop over time.

The challenge is to create sufficient momentum so that capital market capacity can be established by the time insurance capacity starts coming under stress. Capital markets are likely to want to take standardised risks, such as those aligned to national populations, and at shorter durations than required for a full longevity hedge. National population index protection is effective in theory for some pension plans, and carefully crafted models will demonstrate high levels of hedge effectiveness. But real risk transfer is much lower than the 100% offered by an indemnity longevity hedge. Consequently, true capital market structures are unlikely to be used to a great extent by pension plans.

Instead it will be re/insurers who are best positioned to carry basis risk and transfer longevity exposures to capital markets, even if only the standardised, shorter-dated elements, to free up their own capacity. This will enable them to write more of the scheme-specific indemnity longevity protection that pension plans need in the form of bulk annuities, longevity insurance or other solutions.

The need for action
All of the stakeholders involved — including government, re/insurers, other financial service providers, pension plans and employers — must find ways to address the challenges associated with longevity risk transfer. All parties need to come together for open discussions and take the action needed to ensure the issue can be dealt with before it becomes too late.

Acting sooner rather than later is essential, unless pension plans are to be saddled with liabilities they cannot afford, and find themselves unable to transfer. The good news — at least for the moment — is that capacity from the re/insurance industry still remains available for those who have the foresight and appetite to address the longevity risk on their balance sheet.

So far, the UK has led the world when it comes to recognising and dealing with longevity and other risks associated with pension exposures. But the journey is just beginning and, while it will not end with all longevity risk being transferred from those who currently hold it, there is a long road to tread before stakeholders in all markets around the world develop the same degree of risk awareness with respect to longevity. The sooner they do so, the better.


Costas Yiasoumi is head of pension solutions at Swiss Re