Canada's financial regulator is sounding the alarm about the growing array of products that allow investors to bet on how long people will live.
Financial institutions - largely reinsurers - are coming up with products aimed at pension plans and insurers that are grappling with "longevity risk." That's the risk that their pensioner or annuity customers will live longer than they expected, a scenario that could leave them short of funds to make payments.
A longevity market has recently developed in Britain, and reinsurers are now looking to create one in Canada, where there are roughly $1-trillion worth of pension liabilities.
This is a concern for Julie Dickson, head of the Office of the Superintendent of Financial Institutions. So far in Canada there has only been one so-called longevity transaction "and we are advising caution among industry players when assessing these risks," Ms. Dickson told a gathering of insurance executives in Toronto on Tuesday. She wants to be sure that insurers, pension plans, and the capital markets arms of banks understand exactly what risks they're taking on or transferring if they choose to get involved in this market.
As a result of medical advances and healthier lifestyles, people are living longer, and no one knows just how far lifespans could stretch. Pension funds as well as insurers that offer annuity products that guarantee payouts for life are facing the risk that their pensioners or customers will live longer than anticipated, requiring more payments. Underestimating life expectancy by just one year, a relatively small miscalculation, can increase liabilities by up to 5 per cent, according to a report by Swiss Re.
Experts say pension plans and insurers are concerned and hunting for new ways to protect themselves, and reinsurers are seeking to cash in on the trend by finding ways to transfer the risk. For now, reinsurers in Canada are hoping to sell new types of products directly to pension plans and insurers, ones that essentially pay out if pensioners live too long. But ultimately, these products could be packaged up and sold as longevity bonds, transferring risk to banks and investors.
It's a market that's already gathering steam in Britain, and one that players such as Swiss Re are hoping will soon grow in this country.
"It's emerging," said Sharon Ludlow, chief executive officer of Swiss Re's Canadian company, who noted that it represents a big business opportunity. "We have a lot of interested parties and there are a lot of interesting discussions that are going on."
A report by Swiss Re notes that "there is overwhelming consensus that life expectancy will continue to increase," as people smoke less, eat healthier, exercise and take advantage of new medical developments. But skeptics believe that rising obesity rates, more stress, and new viruses and diseases could eat away all or some of the gains in lifespans.
The one Canadian longevity transaction that's taken place, which Ms. Dickson referred to, was one in which an insurer did a deal with a reinsurer that will pay off if its annuity customers live longer than expected.
While traditional life insurance businesses benefit when customers live longer, those gains could be offset by pain in insurers' annuity businesses if they don't take precautions. The risks embedded in annuity businesses hit home in 2008 when stock markets plunged, causing large problems for insurers who hadn't reinsured or hedged their stock exposure. Now some are giving more thought to their longevity exposure.
The recent Canadian transaction was seen by industry players as the first step in the development of a longevity market in this country. Deals with pension plans in Canada could be next, with reinsurers such as Swiss Re looking to do deals directly with corporations that have employee plans.
"I believe that there will be demand for pension risk transfer techniques and innovations in the Canadian market," said Amy Kessler, head of Prudential Financial Inc.'s longevity reinsurance effort. Other countries are further ahead, most notably Britain, where this month Prudential completed its first longevity reinsurance deal. In that deal, Prudential is reinsuring longevity risks that belonged to a British-based subsidiary of Goldman Sachs Group Inc. The deal covered pension account values of $160-million (U.S.).
Swiss Re recently tested the capital markets' appetite for longevity risk by experimenting with its first longevity bond. The small, $50-million bond issue in December allowed investors to bet on the longevity of two specific populations (males between the ages of 75 and 85 in England and Wales, and males aged 55 to 65 in the U.S.).
That test deal was well subscribed, giving Swiss Re comfort that there is an appetite for these securities, Ms. Ludlow said. A group of insurers, reinsurers and banks, including Swiss Re, Deutsche Bank, JPMorgan, Morgan Stanley and UBS, have created a London-based organization called the Life and Longevity Market Association whose aim is to promote a liquid trading market in longevity risk.
Whether it's securitization or changes in government policies, something more will have to be done to help pension plans and insurers deal with the growing problem of longevity risk, experts say.
"The reinsurance market is large, but there's not a lot of people out there with huge capacity to provide longevity insurance," said Don Guloien, chief executive officer of Manulife Financial Corp. "I think other solutions probably have to be provided."