Longevity hedging roundtable: encouraging innovation in the longevity market | Insight Investment

Key Challenges

1. There seems to be a considerable disconnect between perceptions of supply and of end-user demand, leading to an imbalance within the market. The roundtable highlighted that there is considerable demand from pension schemes, in addition to substantial supply from reinsurers  and alternative capacity providers; however, the number of transactions carried out remains relatively small.

2. Given the cost and complexity of implementing an indemnity-based longevity hedge, there is a potential market for simpler structures targeting the same outcome with less precision, but at a lower pricing point. By reducing cost, the longevity market could be more easily accessed by smaller schemes, increasing transaction volumes.

3. Lack of expertise from pension schemes – and long timescales – can make entering into longevity transactions appear overly difficult. However, with the recent increase in the number of professional trustees, pension trustee boards are now better able to handle complex transactions.

4. Lack of liquidity is perceived to be holding back the longevity market; pension funds are looking for structures that offer the ability to unwind longevity protection at a non-punitive cost as their circumstances change.

5. Overly complex, bespoke legal documentation is time consuming and difficult to develop and interpret. Simplification and/or standardisation of transaction documentation could significantly benefit the market.

6. Deferred longevity risk is more challenging – and therefore relatively more expensive – for reinsurers to cover, given greater uncertainty over the longevity of younger pension scheme members; the extent of capital required to support the risk; and the associated administrative burden.

7. There is scope for innovation involving some longevity risk being passed to the capital markets in order to deepen the pool of capital supporting the market, but activity in this area is currently very limited.

• Despite the apparent disconnect between supply and demand in the market, there is serious interest among pension funds to engage on longevity. We believe that there is material demand in the market and that pension schemes are willing to pay for the protection, subject to reasonable secondary liquidity, particularly in respect to the potential to novate to a buy-in or buy-out.

• Irrespective of whether longevity hedging takes off, pension scheme longevity risk will likely end up on reinsurer balance sheets when schemes reach their ultimate endgame and move to buy-out. Reinsurers have an opportunity to help pension schemes on their de-risking journey by taking on a scheme’s longevity risk before it reaches its ultimate endgame. The industry should create an environment where stakeholders come together to make this happen.

• Making the implementation process easier would benefit the market. Employing a set of standard agreements and documents should bring transaction costs down. The buy-in market has already become relatively commoditised, indicating that this objective is achievable.

• Adoption of fixed fee structures would incentivise consultants and lawyers to complete transactions more efficiently.

• Standardised documentation better supports novation of longevity swaps to buy-in/outs, facilitating the journey to an endgame.

• More transparency regarding existing transactions – and associated public availability of data – would allow more meaningful academic research, leading to a better understanding of the risk and ultimately encouraging more risk takers into the market.

• Increased courage/boldness from key stakeholders in innovating the market: Starting with a few, simple such transactions could provide confidence to the market, which will ultimately result in a greater influx of capital and increased liquidity.

• A change in the mind-set of trustees and consultants. There must be a willingness to consider a range of solutions; not simply focusing on solutions that others have already used.

• If schemes are willing to think about longevity risk differently, and are able to better express what they are looking to achieve, there may be multiple ways to mitigate the risk.

• Engaging with regulators early will mean that when new approaches / structures launch within the market, there is sufficient understanding and support to ensure that they are relatively friction free.