longevity bonds or securitizing longevity dr. rodolfo wehrhahn, acli

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Longevity Bonds or Longevity Bonds or Securitizing Longevity Securitizing Longevity Dr. Rodolfo Wehrhahn, Dr. Rodolfo Wehrhahn, ACLI ACLI

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Page 1: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

Longevity Bonds orLongevity Bonds orSecuritizing LongevitySecuritizing LongevityDr. Rodolfo Wehrhahn, Dr. Rodolfo Wehrhahn, ACLI ACLI

Page 2: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, 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

Page 3: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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?

Page 4: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 5: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 6: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 7: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 8: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 9: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 10: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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%

Page 11: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 12: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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%

Page 13: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, 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

Page 14: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 15: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 16: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 17: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 18: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 19: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 20: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 21: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 22: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, 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

Page 23: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 24: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 25: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 26: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 27: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 28: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, 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

Page 29: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 30: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 31: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 32: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 33: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 34: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

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

Page 35: Longevity Bonds or Securitizing Longevity Dr. Rodolfo Wehrhahn, ACLI

Longevity Bonds orLongevity Bonds orSecuritizing LongevitySecuritizing LongevityDr. Rodolfo Wehrhahn, Dr. Rodolfo Wehrhahn, ACLI ACLI