Swiss Re proposes solutions to ageing population problem
A capital market for longevity risk could help pension funds and insurers face the growing challenge of funding longer lives, a report from Swiss Re has claimed.
The 20-page report, Building a Capital Market for Longevity Risk, said a liquid market could form part of an overall solution, involving co-operation between public and private sectors, to address the funding problems caused by an ageing population.
It acknowledged that reinsurance and insurance companies already offered cost-effective solutions to protect against longevity risk, such as annuities offered to individuals and pension plans, or longevity insurance – sometimes called indemnity longevity swaps – for pension funds and insurance clients.
However recent estimates suggest the average pension fund scheme is underfunded by 24 per cent. Defined benefit assets that are exposed to longevity risk total more than $20 trillion (£12.3 trillion) globally.
The report claimed the scale of longevity risk is now so vast that reinsurers cannot take on the risk in the long term. This means capacity is unlikely to meet the future demand for longevity products without the creation of a capital market.
For instance, there are large global institutions with pension liabilities much greater than their total market capitalisation. For such companies, even relatively modest increases in pension liabilities due to higher life expectancy could destroy a significant proportion of shareholder value.
The report argued society’s longevity risk could be tackled if reinsurers expanded their capacity. This could be done by encouraging capital markets investors to invest in longevity instruments to provide long-term longevity risk capacity.
Existing capital markets, such as equity and bond markets, allow companies to raise funds by letting investors participate in the company’s profits. This involves promising to pay investors a premium to compensate them for risks to which they are exposed.
Developing longevity capital markets would be similar. It would involve creating instruments allowing a seller of longevity risk to pay a premium, or coupon, to investors and in return investors would assume the risk of losing some, or all, of their investment if future improvements in life expectancy were higher than a pre-agreed rate.
Alison Martin, head of life and health reinsurance for Swiss Re, said: “A capital market for longevity risk will be vital for the insurance industry in the long term.
“We will work together with other stakeholders in society to create a system that is sustainable throughout people’s longer lives.”
Amanda Davidson, director of London-based Baigrie Davies, said: “The strains of running a final salary pension scheme have been well documented and do require some creative thinking to ensure the cost is not so burdensome, so I welcome Swiss Re’s thinking. It’s nice to see companies are thinking of solutions to this problem.”