In summary
People are living longer than previously expected, and, as a result, companies must address future unanticipated increases in pension liabilities which could potentially threaten their economic viability. Since 2006, insurance companies have provided solutions to hedge this longevity risk.
However, the insurance industry is not large enough to insure all the risk on a global basis.
The research on mortality forecasting models, longevity bonds and swaps, and longevity risk hedging has led to the development of the Life Market (LM), a new global capital market for transferring longevity risk from pension schemes and annuity providers to reinsurers and capital-market investors.
The market has helped to reduce the cost of longevity risk transfers, so pension schemes are now paying less to have their members' pensions reinsured, and those members can now have greater confidence their pensions will be paid in full.
What did we explore and how?
Professor Blake and his co-researchers have been exploring a solution to the problem of longevity risk for two decades. They developed the idea of longevity bonds and swaps to hedge systematic or aggregate longevity risk.
A new stochastic mortality model, the Cairns-Blake-Dowd (CBD) model, was used in the design and development of these instruments. The world’s first longevity swap took place in 2007, while the first successful launch of a longevity bond was in 2010.
The next important step was to recognise the essential role national population mortality indices, calculated by an independent agent, would play in the creation of a liquid traded LM.
The first examples were the LifeMetrices Indices introduced in 2007. These were designed by JP Morgan, in partnership with the Pensions Institute, using official mortality data based on the populations of England & Wales, the US, Holland, and Germany, with Towers Watson as the independent calculation agent.
The potential role government could play in the development of the LM, by establishing a market price for longevity risk, was also considered.
Finally, the researchers recognised the importance of giving new capital-market investors confidence in the integrity of the Life Market, and set out ways of doing so.
Benefits and influence of this research
Professor Blake's research was instrumental in Swiss Re heeding the reasons for the failure of the first attempt to issue a longevity bond in 2004, and designing and successfully launching the $50 million Kortis bond in 2010.
His research has also contributed to significant success in the use of longevity swaps to hedge longevity risk. There have been a total of 61 swaps, worth £105bn, in the UK to December 2020, and 7 index-based swaps in the Netherlands since 2012.
The Longevity Risk Transfer, Investment & Pension Solutions division of US insurer Prudential Financial uses one of the CBD models to provide more accurate pricing for longevity swaps.
The company reports that the model has contributed to a reduction in the price it charges clients by nearly 1%. Since UK pension funds have hedged approximately £100bn in liabilities, the estimated industry savings is £1bn.
Furthermore, both the European Insurance and Occupational Pensions Authority (EIOPA) and the UK Prudential Regulation Authority have recommended the CBD model.
The research continues to be disseminated in publications, and through events such as the annual Longevity Risk Conference.
In addition to the Life Market's economic value to the insurance and pension industries, it can also help companies unwind legacy defined benefit pension liabilities that can prove a drag on performance. Consequently, company shareholders enjoy benefits too.
