Over the coming weeks in this blog I will explore various aspects of longevity risk and the securities related to it. This is a fascinating new area of the capital markets and one sure to become increasingly important this decade. Interestingly, Peter Drucker picked up on this over ten years ago when he wrote:
By providing financial protection against the major 18th and 19th century risk of dying too soon, life insurance became the biggest financial industry of that century… Providing financial protection against the new risk of not dying soon enough may well become the next century’s major and most profitable financial industry. [1]
Since the onset of the liquidity squeeze in 2007, adverse market experience in the traditional asset classes of equities, fixed income and real estate has had a number of impacts on the fortunes of investors. The re-emergence of increasing correlations across major global asset classes (yet again) has encouraged the exploration of alternatives such as infrastructure, private equity and hedge fund strategies as managers seek to diversify and explore new sources of return. In this search, longevity assets have appeared on the capital markets landscape and offer significant potential for the future providing both risk mitigation and a source of enhanced return.
Aside from excessive capital market volatility, longevity risk has created problems for pension plans and annuity providers especially. The aging global population is seeing the number of people nearing retirement explode. This growth increases the risk of underestimating mortality improvements. According to the Pension Protection Fund, each additional year of life expectancy at age 65 increases the present value of pension liabilities by approximately 3%.
In the current environment of historically low yields and increasing investment horizons, individuals are looking to alternate sources of cash to fund retirement including like reverse mortgages, life settlements and annuities. Pension sponsors, facing massive funding deficits have turned, in some cases, to risky and/or illiquid strategies such as private equity and infrastructure investing. More recently, they have seen methods to hedge their long term longevity risk through buyouts and swaps.
The following blog entries will elaborate on these issues and provide some background as to how to participate in the longevity and life markets.
[1] Drucker, Peter: The Economist “Innovate or die”, September 25, 1999