longevity bonds or securitizing longevity dr. rodolfo wehrhahn, acli
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Longevity Bonds orLongevity Bonds orSecuritizing LongevitySecuritizing LongevityDr. Rodolfo Wehrhahn, Dr. Rodolfo Wehrhahn, ACLI ACLI
Copyright American Council of Life Insurers 2005
ContentsContentsContentsContents
Should I care about longevity risk?
How does securitization work?
Should I care about securitization of longevity?
Longevity bonds and beyond
Copyright American Council of Life Insurers 2005
Should I care about longevity risk?Should I care about longevity risk?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?
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?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
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?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
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?Life Expectancy at Birth US Population Data
1900 47.3
1950 68.21960 69.71970 70.81980 73.71990 75.52000 77.4
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?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
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?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
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?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
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?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%
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?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
Copyright American Council of Life Insurers 2005
Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?Should I Care About Longevity Risk?
Mortality Changes That Can be Absorbed
IncreasePricing in Life Reduction inSpread Expectancy Mortality
25bp 1 year 9%50bp 2 years 18%75bp 3 years 27%
100bp 4 years 36%130bp 5 years 45%
Copyright American Council of Life Insurers 2005
ContentsContentsContentsContents
Should I care about longevity risk?
How does securitization work?
Should I care about securitization of longevity?
Longevity bonds and beyond
Copyright American Council of Life Insurers 2005
How does securitization workHow does securitization workHow does securitization workHow 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
Copyright American Council of Life Insurers 2005
How does securitization workHow does securitization workHow does securitization workHow 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
Copyright American Council of Life Insurers 2005
How does securitization workHow does securitization workHow does securitization workHow 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
Copyright American Council of Life Insurers 2005
Structure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed Security
Originator
Customer
Product Payment
Copyright American Council of Life Insurers 2005
Structure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed Security
Investor Originator
Customer
Asset Backed Security
Product Payment
Cash
Asset
Securities
Investment
Copyright American Council of Life Insurers 2005
Structure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed Security
Swap Counterparty
Investor Originator
Customer
Asset Backed Security
Product Payment
Cash
Asset
Fixed Rate Floating Rate
Securities
Investment
Copyright American Council of Life Insurers 2005
Structure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed SecurityStructure of an Asset Backed Security
Swap Counterparty
Credit Enhancement Mechanism
Investor
Originator
Customer
Asset Backed Security
Product Payment
Cash
Asset
Fixed Rate Floating Rate
Securities
Investment
Guarantee Premium
Copyright American Council of Life Insurers 2005
How does securitization worksHow does securitization worksHow does securitization worksHow 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
Copyright American Council of Life Insurers 2005
ContentsContentsContentsContents
Should I care about longevity risk?
How does securitization work?
Should I care about securitization of longevity?
Longevity bonds and beyond
Copyright American Council of Life Insurers 2005
Should I care about Securitization of longevityShould I care about Securitization of longevityShould I care about Securitization of longevityShould 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
Copyright American Council of Life Insurers 2005
Securitization of longevity as a risk managing Securitization of longevity as a risk managing tooltoolSecuritization of longevity as a risk managing Securitization of longevity as a risk managing tooltool
Tail risk reduction or elimination
Reduce or eliminate adverse mortality experience
Diversification of the risk
Uncorrelated investment
Hedging tool
Copyright American Council of Life Insurers 2005
Securitization of longevity as a risk managing Securitization of longevity as a risk managing tooltoolSecuritization of longevity as a risk managing Securitization of longevity as a risk managing tooltool
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
Copyright American Council of Life Insurers 2005
Securitization of longevity as a source of Securitization of longevity as a source of financingfinancingSecuritization of longevity as a source of Securitization of longevity as a source of financingfinancing
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
Copyright American Council of Life Insurers 2005
Securitization of longevity as a source of Securitization of longevity as a source of financingfinancingSecuritization of longevity as a source of Securitization of longevity as a source of financingfinancing
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
Copyright American Council of Life Insurers 2005
ContentsContentsContentsContents
Should I care about longevity risk?
How does securitization work?
Should I care about securitization of longevity?
Longevity bonds and beyond
Copyright American Council of Life Insurers 2005
Examples of SecuritizationsExamples of SecuritizationsExamples of SecuritizationsExamples of Securitizations
SPV Amount
(US $Mil)
S& P
Rating
Issue
Date
Maturity Spread Premium to
LIBOR
(bps)
Queensgate Spl Purp A
Quensgate Spl Purp B
Queensgate Spl Purp C
Vita Capital II Ltd. B
Vita Capital II Ltd. C
Vita Capital II Ltd. D
175.0
45.0
25.0
62.0
200.0
100.0
A+
BBB
BBB
A-
BBB+
BBB-
Dec-04
Dec-04
Dec-04
Apr-05
Apr-05
Apr-05
Dec-24
Dec-24
Dec-24
Jan-10
Jan-10
Jan-10
146
247
90
140
190
Copyright American Council of Life Insurers 2005
Longevity BondLongevity BondSummary of TermsSummary of TermsLongevity BondLongevity BondSummary of TermsSummary 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
Copyright American Council of Life Insurers 2005
Longevity BondLongevity BondSummary of TermsSummary of TermsLongevity BondLongevity BondSummary of TermsSummary of Terms
Bond Payoff £50 million * CSRt
CSRt Cumulative survival rate at time t
Index Published ONS Publication DH1 Mortality Statistics Table 8
Payment FrequencyAnnual
Copyright American Council of Life Insurers 2005
Longevity BondLongevity BondCash Flow ProfileCash Flow ProfileLongevity BondLongevity BondCash Flow ProfileCash Flow Profile
0
10
20
30
40
50
60
1 3 5 7 9 11 13 15 17 19 21 23 25
Years
Bo
nd
Pa
yo
ff
Longevity higher than expected
Longevity lower than expected
Copyright American Council of Life Insurers 2005
Longevity BondLongevity BondAnnual Payment DeterminationAnnual Payment DeterminationLongevity BondLongevity BondAnnual Payment DeterminationAnnual Payment Determination
Payment year 2005 2006 2007
Reference year 2003 2004 2005
Age of cohort 65 66 67
Annual mortality rate 1.50% 1.80% 2.10%
Annual survival rate 98.50% 98.20% 97.90%
Cumulative survival rate 98.50% 96.73% 94.70%
Payment (£1,000 base) £985.00 £967.30 £947.00
Copyright American Council of Life Insurers 2005
Longevity bonds and beyondLongevity bonds and beyondLongevity bonds and beyondLongevity bonds and beyond
Challenges going forward:
Cost and complexity of issuing
Market interest: risk- return ratio
Secondary market creation
Longevity Bonds orLongevity Bonds orSecuritizing LongevitySecuritizing LongevityDr. Rodolfo Wehrhahn, Dr. Rodolfo Wehrhahn, ACLI ACLI