Longitude Solutions first market update of 2019 contains some company news and discusses the following market topics: Insurance Linked Securities (ILS), the Dutch pension fund’s attitude towards longevity risk, and topics related to index-based longevity hedges.
Alan Rae Presents on Index-Based Hedging
Longitude’s senior partner Alan Rae spoke at the UK Actuaries Life Conference in Liverpool on 23rd November 2018 together with Professor Andrew Cairns (Heriot Watt University) on “Index Based Longevity Hedging – The Dutch experience to date and challenges for the future”.
In the presentation, Alan and Andrew outlined the structure of the hedges developed for use by Dutch insurers in the run-up to Solvency 2, summarized the transactions executed to date, and explained the Solvency 2 treatment of those transaction, in particular the quantification of basis risk.
In their closing remarks they concluded that basis risk can be quantified, and that the hedge structure – in particular the choice of exhaustion point – can be used to minimize any mismatch. Further, they foresaw that UK insurers and pension funds would revisit the use of index-based hedges, especially for exposures with a high proportion of deferred annuitants as these are tricky to hedge using traditional longevity swaps.
Interest in ORSA & Recovery Plans
We’ve been interested, in recent months, to have received numerous requests from clients concerning Own Risk Solvency Assessment (ORSA) as well as recovery plans. In contrast to the more typical discussion centered around clients’ immediate needs for longevity risk-transfer, a growing number of risk managers are keen to develop a thoroughly prepared recovery scenario that would enable them to implement a longevity hedge within a much shorter timeframe. This preparation, and the compressed transaction timeline it affords, are made possible by Longitude Solution’s proprietary longevity toolkit and experience preparing hedgers for the transaction process.
Longevity De-Risking for Dutch Pension Plans
Contrary to UK pension funds, the pension funds in the otherwise lively longevity market of the Netherlands, have not executed any “longevity risk only” deals so far. While the market for buy-outs, and recently also buy-ins, has been very active, no longevity-only hedges have been executed by a pension fund. We believe this is mostly due to the relative size of longevity risk compared to other risks (e.g., market) and/or the financial position of these funds.
What these pensions may be overlooking though, is that hedging longevity risk eliminates funding level volatility, as well as creates additional risk budget for asset strategies. To date they may have only considered solutions designed to hedge the full longevity risk spectrum but found the cost unpalatable. Longitude Solutions believe that hedges which address only part of the risk spectrum (first-loss or tail-risk) could deliver a more customized longevity risk profile at a strongly reduced price.
Addressing Basis Risk in Index-Based Longevity Hedges
Basis risk, resulting from the use of an index to hedge longevity risk, is a topic that has received much academic attention as well as regulatory scrutiny. Solvency II requires hedgers to consider all relevant aspects of basis risk: model points matching the underlying liability, commutation mechanisms covering longevity risk beyond hedge maturity, and divergence in the mortality experience of the hedged and general populations.
A lively and constructive discussion on basis risk took place at the Longevity 14 conference in Amsterdam last September with the Solvency Supervisor at DNB. Mr. van Gastel’s speech, which immediately followed Avery Michaelson’s talk on longevity investment opportunities, addressed a regulator’s concerns when considering longevity de-risking proposals, while at the same time welcoming a broadening of the longevity investor universe.
As a follow-up to this discussion, Longitude’s senior partner, David Schrager, is currently cooperating with university researchers to develop a methodology for basis risk measurement that captures all aspects of basis risk.
Capital Markets Interest in Longevity Risk
Longitude Solutions is sometimes asked whether capital market investors will stay in the longevity market if interest rates rise or equities enter a bear market. Our view is that, while there may certainly be ups and downs to certain investors risk appetite, the general trend will remain positive for new entrants as well as additional capital dedicated by established players. See Leadenhall and ILS Growth.
Capital market investors face an attractive proposition when investing in longevity risk given uncorrelated returns with less volatility than traditional P&C risks. Given that most ILS funds target an absolute, rather than relative, return proposition to their investors, and that interest rates remain well below that hurdle, there’s no reason to expect capital to shy away from the longevity market any time soon. We also see reinsurers increasingly partnering with capital markets investors, and consultants continuing to strengthen their capital markets capabilities.
Please reach out to one of our partners if you would like to discuss any of these topics in detail.