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Longevity: a new asset class

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Abstract

A little over a decade ago, a new asset class emerged, one linked to longevity risk, i.e., unanticipated changes in life expectancy. The Life Market has two segments: a macro-segment with assets linked to groups of lives, such as members of a pension plan or a book of annuitants; and a micro-segment with assets linked to individual lives, such as life settlements. For the market to become global, certain market requirements need to be satisfied, such as understanding the causal factors underlying longevity and the development of market indices and mortality forecasting models. The government has a role in contributing to the development of the market, as do pricing models. By addressing these issues, as well as understanding the needs of investors better, the asset class can become global, by attracting new groups of investors seeking returns that are uncorrelated with existing financial instruments.

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Fig. 1

Source: Prudential

Fig. 2

Source: Oeppen and Vaupel (2002) Broken limits to life expectancy

Fig. 3

Source: PNMA00 medium cohort

Fig. 4

Source: Shaw (2007, Fig. 5)

Fig. 5

Source: UK Office for National Statistics

Fig. 6

Source: Coughlan (2011)

Fig. 7

Source: J.P. Morgan LifeMetrics data

Fig. 8

Source: Office for National Statistics

Fig. 9

Source: Longitudinal Study, Office for National Statistics

Fig. 10

Source: Cairns et al. (2017)

Fig. 11

Source: Office for National Statistics

Fig. 12

Source: RMS (2010) ‘Longevity Risk’

Fig. 13
Fig. 14
Fig. 15
Fig. 16

Source: Coughlan et al. (2007, Figure 1)

Fig. 17
Fig. 18

Source: Michaelson and Mulholland (2015, Exhibit 3)

Fig. 19
Fig. 20

Source: Michaelson and Mulholland (2015, Exhibit 3)—not drawn to scale

Fig. 21

Sources: LIMRA, Hymans Robertson, LCP and PFI analysis as of December 31, 2017

Fig. 22

Source: Blake et al. (2014)

Fig. 23

Source: Coughlan (2011)

Fig. 24

Source: Coughlan (2011)

Fig. 25

Source: PFI

Fig. 26

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Notes

  1. This is the risk that people will live longer than expected, so that pension plans and annuity providers (and reinsurers) make payments to members and policy holders for much longer than anticipated.

  2. With a buy-out, an insurance company buys out the liabilities of a pension plan which is paid for with the pension plan assets and a loan if the plan is in deficit at the time. Both the pension plan assets and liabilities are removed from the corporate sponsor’s balance sheet. Each member has a personal annuity from the insurer who takes over responsibility for paying their pension. This contrasts with a buy-in, where the liabilities remain on the sponsor’s balance sheet, but the plan buys bulk purchase annuities (BPAs) from an insurance company and pays members’ pensions from the annuity payments it receives from the insurer. The BPA is an asset of the plan, not the members. The world’s first specialist buy-out company was Paternoster which was established in the UK in 2006. This was closely followed by the Pension Insurance Corporation (also in 2006) and Lucida and Rothesay Life (both 2007). Paternoster executed the first buy-out in November 2006 of the Cuthbert Heath Family Plan, a small UK plan with just 33 members. It also executed the first pensioner buy-in with Hunting PLC in January 2007. Paternoster was bought by Rothesay Life in 2011, while Lucida was acquired by Legal & General in 2013.

  3. Michaelson and Mulholland (2015).

  4. Basis risk is the residual risk associated with imperfect hedging where the movements in the underlying exposure are not perfectly correlated with movements in the hedging instrument.

  5. https://llma.org/.

  6. See Cairns et al. (2006, 2009).

  7. See Dowd et al. (2010).

  8. See Blake et al. (2008).

  9. It was based on the bond design in Blake and Burrows (2001).

  10. For further details, see Blake et al. (2006).

  11. This is the risk that people die sooner than expected, so that insurance companies that sold life policies (and reinsurance companies that reinsured them) make payouts under these policies sooner than was anticipated, before the full set of projected premiums had been collected.

  12. For further details, see Blake et al. (2006).

  13. For further details, see Hunt and Blake (2015).

  14. For further details, see Coughlan et al. (2007) and Blake et al. (2013).

  15. See Dowd et al. (2006).

  16. For further details, see Blake et al. (2013).

  17. For further details, see Blake et al. (2013).

  18. See, also, Cairns and El Boukfaoui (2018) for a more detailed description.

  19. This is the risk that arises when a hedger is not able for some reason to put on a single hedge that covers the full term of its risk exposure and is forced to use a sequence of shorter-term hedges which are rolled over when each hedge matures, with the risk that the next hedge in the sequence is set up on less favorable terms than the previous one.

  20. This is the value paid by the original life company to cancel the policy.

  21. A whole life policy has two components, a life insurance component and an investment component: periodic premiums (monthly, quarterly, annual, single, for example) cover the cost of the life insurance, with the surplus going into an investment fund. In the US market, the insurance company typically invests the surplus premium in fixed-income securities to build up a ‘cash value.’ The cash value is separate from the ‘face value’ of the policy, which is the guaranteed insurance value.

  22. www.lisassociation.org.

  23. www.lifemarketsassociation.org.

  24. http://www.ils-us.com/.

  25. It is an expensive process to acquire suitable life policies for settlement with a range of intermediaries who need paying. In addition, premiums need to be financed. There is also a laborious process of monitoring policy holders between the purchase and policy maturity dates. In addition, there are ethical issues associated with the sale of policies by elderly individuals: these issues were considered by, among others, Blake and Harrison (2008).

  26. www.islsp.org.

  27. www.bvzl.de.

  28. www.elsa-sls.org.

  29. Pension Commission (2005, p. 229).

  30. \(RP = CoC\sum\limits_{t = 1}^{T} {\frac{LCR\left( t \right)}{{\left( {1 + r} \right)^{t} }}}\) where r is the risk-free discount rate.

  31. As an analogy, Table 3 shows how the risk premium increases with the deferral period in the case of longevity bonds.

  32. This is the case for a transaction involving a pension plan and an insurer, where allowance is made for the insurer’s cost of capital and normal profit, etc. In a transaction involving an insurer and a reinsurer, it is typical for fees to be added to the ‘fixed leg,’ so commercially there will be a loss to the cedant on day 1.

  33. International Swaps and Derivatives Association.

  34. The longevity bull call spreads in Section “Longevity bull call spreads (or tail-risk protection)” had to reflect such compromises in order to be implemented.

  35. It is not an issue for a pension plan if it is doing a longevity swap as a step towards a full buy-out.

  36. For further details, see Blake et al. (2018) and Bugler et al. (2018).

  37. See, e.g., Akerlof (1970).

  38. That is, specific individual cashflows that give rise to the greatest uncertainty in value terms.

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  1. Pensions Institute, Cass Business School, London, UK

    David Blake

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Blake, D. Longevity: a new asset class. J Asset Manag 19, 278–300 (2018). https://doi.org/10.1057/s41260-018-0084-9

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