Friday, August 16, 2013

Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks - consultative report

Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks - consultative report
The Joint Forum
August 2013

The ageing population phenomenon being observed in many countries poses serious social policy challenges. Longevity risk - the risk of paying out on pensions and annuities longer than anticipated - is significant when measured from a financial perspective. Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks (PDF) is a forward-looking report released by the Joint Forum on longevity risk transfer (LRT) markets.


Whether or not policymakers should play a more active role in encouraging longevity risk transfer from private pension plans to (re)insurers and ultimately to broader capital markets depends on considerations regarding where this risk is best held. Answering this question is beyond the scope of this preliminary analysis, but some relevant factors are worth mentioning.

Advocates of more LRT (see, e.g., Towers Watson, 2011, and Swiss Re, 2012) point to already visible and unwieldy corporate pension benefit obligations and to the heavy underfunding of DB pension funds.31 In this context, they recognise that not only are pension obligations a sizeable distraction to corporate core business lines, but a significant longevity shock could undermine the firm’s own existence. In addition, they point out that some LRT instruments (namely buy-outs) may provide pensioners with a more stringently regulated (re)insurer counterparty.

In addition, policymakers may want to encourage (re)insurers to use LRT markets to free up capital in order to give (re)insurers (or any other entities allowed to provide annuity products) the possibility of writing more of these annuities, which are useful and unique retirement products. On the other hand, the transfer of risk from a mature sector with significant capital requirements to an LRT market that may not have these safeguards may not be in the employees’ best interests, and may even create new systemic risks.

At the same time, when longevity risk is shifted from the corporate sector to a limited number of (re)insurers, with global interconnections, there may be systemic consequences in the case of a failure of a key player (as was the case in the CRT market). Most countries in which this view is shared incentivise the private sector to provide adequate retirement benefits to employees, sometimes providing explicit protection to corporate pension funds with government-supported guarantee schemes. In other countries, this view is expressed implicitly by allowing pension funds to value their liabilities with a discount rate that is higher than the one used for (re)insurers’ reserves.

Motivated by the aforementioned preliminary findings, the Joint Forum proposes the following recommendations to supervisors and policymakers:
  1. Supervisors should communicate and cooperate on LRT internationally and cross-sectorally in order to reduce the potential for regulatory arbitrage.
  2. Supervisors should seek to ensure that holders of longevity risk under their supervision have the appropriate knowledge, skills, expertise and information to manage it.
  3. Policymakers should review their explicit and implicit policies with regards to where longevity risk should reside to inform their policy towards LRT markets. They should also be aware that social policies may have consequences on both longevity risk management practices and the functioning of LRT markets.
  4. Policymakers should review rules and regulations pertaining to the measurement, management and disclosure of longevity risk with the objective of establishing or maintaining appropriately high qualitative and quantitative standards, including provisions and capital requirements for expected and unexpected increases in life expectancy.
  5. Policymakers should consider ensuring that institutions taking on longevity risk, including pension fund sponsors, are able to withstand unexpected, as well as expected, increases in life expectancy.
  6. Policymakers should closely monitor the LRT taking place between corporates, banks, (re)insurers and the financial markets, including the amount and nature of the longevity risk transferred, and the interconnectedness this gives rise to.
  7. Supervisors should take into account that longevity swaps may expose the banking sector to longevity tail risk, possibly leading to risk transfer chain breakdowns.
  8. Policymakers should support and foster the compilation and dissemination of more granular and up-to-date longevity and mortality data that are relevant for the valuations of pension and life insurance liabilities.

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