Longevity risk transfer 

Primary markets
Within a particular country, there are usually a large number of primary providers for annuity products and these products tend to be defined and shaped by the relevant legal and tax regime. This standardization makes comparisons fairly simple for the consumer and enhances the commodity nature of the product. While in some countries the state offers only a subsistence pension, in others a state or company pension will make up the bulk of a pensioner’s post-retirement income. Due to these differences, the extent to which longevity risk is spread between the public and private sector varies from country to country.

It is worth noting that states are generally exposed to a lot of longevity risk, either directly through public pension systems and/or ultimately through the public healthcare system, which in many cases essentially makes the state the insurer of last resort.

Secondary markets
In contrast to this extensive primary market, there is only a very minor secondary risk transfer market available for standard annuity longevity risk. Given the enormous amount of longevity risk concentrated in pension funds and with life insurers, many of whom lack diversification across populations and pension systems, why hasn’t a corresponding active “wholesale” market developed? The main problem seems to be that it has proved difficult to find a price that clears the market.

Risk analysis issues
Uncertainties around future developments in longevity, inadequate data, the “systemic” nature of the risk and the fact that there will probably be similar longevity developments across markets, introduces a significant inherent risk to longevity risk evaluation – which needs to be captured in the price. The result: insurers and pension funds tend to find quotes for risk transfer too high and continue to retain the risk on their own balance sheets. For insurers, the option to retain this risk is aided at least to an extent by the natural hedge in their mortality books (longer lives reduce the overall loss cost of mortality products), however, this hedge is “dirty” at best due to the different age groups that are generally affected.

Mortality, morbidity and longevity are in principle subject to the same underlying risk factors – namely the emergence of new diseases and medical progress in respect of diagnosis and treatments, coupled with country-specific factors such as available healthcare and rehabilitation techniques. The trending of such factors is an established and continually advancing actuarial skill but there will always be uncertainty around the prediction of future mortality trends. The effect of this uncertainty on pricing accuracy is more pronounced on longevity products, primarily because there is less mortality data on advanced age groups on which to base projections, and also because increasing longevity equates to longer longevity product payment (i.e. downside risk to the insurer).

Uncertainty around how longevity will develop
More people are living longer than ever before, but will the maximum age for the human body continue extending, or is there a “hard limit” beyond which very few people will live but which more and more people will reach over time? Will future medical treatments be able to extensively prolong life and at what cost? Will one of the major causes of mortality (for example, cancer) be eliminated in the future, or will new causes gain prominence? There are many questions for which there are no conclusive answers and where there is conflicting evidence on what the answer may turn out to be. Only when we experience a levelling off of longevity developments for a meaningful period of time will we be able to be more confident about predicting future trends, at least over the medium term. Before that occurs, the uncertainty around projections will remain significant.

Insufficient mortality data for advanced age groups
Compared to mortality and morbidity products, annuities are purchased by individuals from a much narrower spread of ages, and also specifically by more advanced ages (e.g. at retirement). While a lot of population and assured lives’ data is available for ages of up to, say, 65 years, less data is available for lives that have survived to more advanced ages (beyond 90), quite simply because increased life expectancy is a recent development. Where available, this data is usually only population data and not for assured lives, which can exhibit significantly different mortality due to the selective nature of annuity purchase. As a result, making confident assessments around population mortality at these higher ages is problematic.

Product developments
Despite the problems described above, there are some areas where there is a growing market for longevity risk.

Bulk sale of standard annuity books
The first is the bulk annuity market, where books of standard annuities have in recent years been sold to annuity providers. So far, these have been large, individual transactions – mainly pension funds selling the risk to insurers who already have the requisite expertise (and a large existing exposure) in longevity risk – rather than there being an open market for this type of business. There does not seem to be any resale activity from purchasers of bulk annuities. The result of such trans-actions is therefore an increasing concentration of risk, rather than the spreading of risk across the market.

Part-sale of annuity portfolios

Another example of how markets are rebalancing longevity risk is via the part-sale of pension risk, such as the executive component, in order to make the sale of longevity risk more affordable to individual funds.

Capital market instruments
For standard lives, there have been some attempts at launching capital market instruments around longevity risk (longevity bonds), but these have so far met with a lukewarm response from the market, again partly because of price.

Impaired Life Annuities
The market has, however, seen a successful product development in the form of impaired life annuities (ILAs), in which policyholders with reduced life expectancies due to illness are offered better annuity terms. The shorter term of such risk makes it easier to control and price. In consequence, risk analysis of “standard” annuities becomes more volatile. As longevity risk, and particularly the impact of specific medical conditions, becomes better understood over time, we can expect impaired life products to become increasingly sophisticated and widespread.

A market poised to gain momentum
More and more primary carriers of longevity risk are indicating an interest in selling off parts of their longevity book, and there is already much more focus on the potential cost of longevity risk during, for example, mergers and acquisitions. This is a result not only of the increasing prominence of longevity risk and its loss potential, but in particular of the move toward more transparent accounting and the use of risk-based capital approaches to record balance sheet liability. If companies and pension funds are forced to hold realistic amounts of capital for their longevity risk, then there is an explicit and visible cost connected with retaining longevity risk. As this cost is likely to be significant, the pressure to move longevity risk off the balance sheet will rise.

The desire to transfer longevity risk is clearly poised to gain momentum, but this will still require consensus in respect of price – necessitating not just new product solutions but also improved pricing confidence through better risk data (which will come with time). The true price of covering standard annuity risk may only be recognized once an external shock to the market place takes place, such as the failure of a pension fund triggered by a significant and previously unanticipated increase in annuitant life expectancy. The state’s role as insurer of last resort in the absence of reinsurance or other capital providers, may also lead to regulatory pressure to better manage this risk.

PartnerRe in the market
At PartnerRe, we offer our clients strong expertise in longevity product development, including associated pricing and underwriting tool realization. In addition to traditional forms of risk transfer, we have developed impaired life annuities, mortality swaps and longevity bonds in partnership with our clients for the mitigation of longevity risk.



What is longevity risk?

Longevity risk is the potential for an adverse
(primarily financial) consequence linked to living longer than expected.

At the personal level, this could result in having insufficient income to maintain a standard of living. The typical way of mitigating such risk is via the
purchase of annuities: state pensions, company
pensions or privately purchased annuities.

Alternately, for the state, longevity risk may mean insufficient resources to support the promises made to a population (e.g. healthcare or public pensions) – due to more than the expected number of people still being alive to claim on those promises.

Longevity risk is a significant problem for life insurers, pension funds and governments, in particular because there is still a lot of uncertainty around how mortality trends will develop