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Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI . Contents. Should I care about longevity risk? How does securitization work? Should I care about securitization of longevity? Longevity bonds and beyond. Should I care about longevity risk?.

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contents
Contents
  • Should I care about longevity risk?
  • How does securitization work?
  • Should I care about securitization of longevity?
  • Longevity bonds and beyond
should i care about longevity risk
Should I care about longevity risk?
  • Pension funds are chosen based on certain characteristics
    • Solvency: today’s and on the long run
    • Investments expertise: best expected returns
    • Administrative skills: high quality service
      • Asset liability management
        • Longevity risk expertise?
should i care about longevity risk1
Should I Care About Longevity Risk?
  • Life expectancy has been increasing for as long as we having taking measurements
    • Improved nutrition and sanitation
    • Better safety and working conditions
    • Widespread immunizations and antibiotics
should i care about longevity risk2
Should I Care About Longevity Risk?
  • How much more improvement can we expect?
    • Medical and technological breakthroughs could lead to important leaps
    • Dr. Aubrey de Grey at the University of Cambridge caused a storm at an aging conference in his assertion that the human lifespan could increase to 1,000 years once medical researchers learn how to fix cell damage
should i care about longevity risk4
Should I Care About Longevity Risk?

Mortality improvement – how big is it?

  • Life expectancy for a 60 year old Chilean annuitant at today’s mortality rates with 1% annual improvements is 22.5
  • Each additional 1% increase in mortality improvement factors lengthens this by 1.5 years
  • Thus, mortality improvement needs to be clearly understood and quantified
should i care about longevity risk5
Should I Care About Longevity Risk?

How mortality improvement & life expectancy relate

  • If a static mortality table is used (with no improvement factors), then every reduction in absolute rates reflects an increase in life expectancy
  • However, when pricing insurance products, life expectancy typically reflects an assumed annual future rate of improvement
    • Thus, it changes only if there is a change in future mortality improvement
    • A 0.25% increase in mortality improvement translates to a 4 month increase in life expectancy
    • So life expectancy will continue to increase only if the mortality improvement factors continue to increase
should i care about longevity risk6
Should I Care About Longevity Risk?

Does mortality improvement vary by age?

  • Mortality improvement scales typically tend to vary by gender and by age
  • Recent Chilean improvement factors were approximately 1% at all ages
  • An unexpected shock would likely affect young and old differently
    • Example – AIDS
should i care about longevity risk7
Should I Care About Longevity Risk?

Impact of changes in mortality on annuity prices

  • A 1% increase in improvement factors reduces the pricing spread by 0.28%
  • A 3% increase in improvement factors reduces the pricing spread by 1.00%
should i care about longevity risk8
Should I Care About Longevity Risk?

Impact of changes in mortality on annuity prices

  • Impact of shock discovery that life expectancy is 5 years longer than expected:
    • Mortality rates would now be approximately 50% of expected
    • Pricing spreads would shrink by 1.3%
    • From this, we can estimate how much of a shock we can absorb, given different pricing spreads
contents1
Contents
  • Should I care about longevity risk?
  • How does securitization work?
  • Should I care about securitization of longevity?
  • Longevity bonds and beyond
how does securitization work
How does securitization work
  • Securitization:

Transforming the value or future cash flows of a given business into financial instruments that can be traded in the capital markets

how does securitization work1
How does securitization work
  • Mortality bonds:

The instruments will pay coupons depending on the mortality performance of the underlying block of business. The coupons or even the principal could be at risk if mortality does not perform well, i.e. there are more deaths than expected

how does securitization work2
How does securitization work
  • Longevity bonds:

The instruments will pay coupons depending on the longevity performance of the underlying block of business. The coupons or even the principal could be at risk if longevity does not perform well i.e. there are less deaths than expected

structure of an asset backed security1

Investor

Securities

Asset Backed Security

Cash

Originator

Investment

Asset

Product

Payment

Customer

Structure of an Asset Backed Security
structure of an asset backed security2

Investor

Securities

Asset Backed Security

Cash

Originator

Investment

Asset

Fixed Rate

Floating Rate

Product

Payment

Swap Counterparty

Customer

Structure of an Asset Backed Security
how does securitization works
How does securitization works

Characteristics of a business that can be securitized

  • Well defined
  • Public and of easy access independent indicators
  • Stable and predictable under “normal” circumstances
  • Large enough to support fluctuations and transactional costs
  • Repeatable
contents2
Contents
  • Should I care about longevity risk?
  • How does securitization work?
  • Should I care about securitization of longevity?
  • Longevity bonds and beyond
should i care about securitization of longevity
Should I care about Securitization of longevity
  • Securitization of longevity as a risk managing tool
    • Mortality risk transfer instrument
    • Hedging tool
  • Securitization as a source of financing
    • Access to the capital markets
    • Uncorrelated investment
securitization of longevity as a risk managing tool
Securitization of longevity as a risk managing tool
  • Tail risk reduction or elimination
  • Reduce or eliminate adverse mortality experience
  • Diversification of the risk
  • Uncorrelated investment
  • Hedging tool
securitization of longevity as a risk managing tool1
Securitization of longevity as a risk managing tool

Life term insurance vs. annuities

  • Mortality improvements have opposite impacts on insurance and annuity products; for example, a 1% increase in mortality improvement factors:
    • Increases an annuity liability by 5%
    • Decreases a typical term liability by 20%
  • These changes are reasonably linear
securitization of longevity as a source of financing
Securitization of longevity as a source of financing
  • A profitable block of business can be the ideal source of low cost financing:
    • It is less sensitive to present economic environment
    • It is relatively independent of the issuer present performance
    • It does not necessarily impact the balance sheet
    • The asset it is already existing and profits can be accelerated
securitization of longevity as a source of financing1
Securitization of longevity as a source of financing
  • A profitable block of business can be the ideal source of low cost financing:
    • It does not necessarily impact the balance sheet
    • The asset is already existing and profits can be accelerated
contents3
Contents
  • Should I care about longevity risk?
  • How does securitization work?
  • Should I care about securitization of longevity?
  • Longevity bonds and beyond
longevity bond summary of terms
Longevity BondSummary of Terms
  • Issued by European Investment Bank
  • Security £550 million longevity linked EMTN
  • Index Publicly available mortality for cohort of 65 year old males
  • Longevity Risk Period Calendar years 2003 to 2027
  • Maturity 25 years
longevity bond summary of terms1
Longevity BondSummary of Terms
  • Bond Payoff £50 million * CSRt
  • CSRt Cumulative survival rate at time t
  • Index Published ONS Publication DH1 Mortality Statistics Table 8
  • Payment Frequency Annual
longevity bonds and beyond
Longevity bonds and beyond

Challenges going forward:

  • Cost and complexity of issuing
  • Market interest: risk- return ratio
  • Secondary market creation
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