Longevity Risk Torben Thomsen XXVI Congreso Nacional de Actuarios, September 2013 For further information please contact: Torben Thomsen torben_thomsen@swissre.com + 44 207 933 4530 Luis Francisco Galvan luis_galvan@swissre.com + 52 55 5322 8328
Agenda Setting the scene Understanding and managing longevity risk Creating a longevity risk market Conclusions 2
Setting the scene 3
Longest life expectancy increases at 3 months per year for the last 150 years Record female life expectancy from 1840 to present Horizontal black lines show asserted ceilings on life expectancy, with a short vertical line indicating the year of publication Dashed red lines denote projections of female life expectancy in Japan published by the United Nations in 1986, 1999, and 2001 Source: Oeppen & Vaupel, broken bounds to life expectancy, Science 2000 4
5% Improvements are significant at post-retirement ages Male Mortality improvements by age 4% 3% 2% 1% 0% 55 60 65 70 75 80 85 90-1% -2% US England & Wales Japan Chile Source: www.mortality.org, lifemetrics, Swiss Re calculation 5
The global longevity risk issue is huge OECD Pension Assets (USD 18.6 Trillion) Other Mexico US Canada Australia Japan UK Chile Euro area Latin America Pension Assets (USD 0.8 Trillion) Brazil Panama Other Colombia Mexico Chile Source: OECD Global Pension Statistics Global longevity exposure estimated as USD 20 trillion of pension assets 90% of exposure related to pension funds;10% pension insurance contracts Insurers exposure dominated by markets with compulsory annuitisation Corporate sponsors exposed to defined benefit pension schemes Governments committed to fund old-age pension/health benefits 6
The holders of longevity risk Government State pension; public sector pensions; long-term and medical care Longevity risk transfer solutions Insurance industry Annuity portfolios Longevity swaps Long-term care Reduced benefits Longevity risk transfer solutions Individual Risk of outliving their assets Closure of defined benefit schemes Employer Defined benefit pensions; retiree medical benefits 7
Understanding and Managing Longevity Risk 8
Key longevity risk factors Parameter risk (current mortality) Trend risk (future mortality) Age Volatility risk Age (birth cohort) 9
Risk Management Strategies Understand Identify risk drivers Quantify exposure Analyse risk scenarios Limit Restrict sales/new entrants Redesign products/benefits Diversify Volume, markets Other product lines Hedge Internal Negative correlated risks External Re/insurance, Capital Markets Exit Sale, Buy-Out Commutation 10
Historically, longevity risk has been underestimated Actual and projected life expectancy at birth, UK males 11
1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Which Model? 0.08 0.07 0.06 The 1-in-a-hundred-year scenario under one model is approximately equal to the mean scenario under the other model 0.05 0.04 0.03 0.02 Lee-carter (standard) Lee-Carter (Age-Period-Cohort) Actual Source: Center for Disease Control data and US Census Bureau data, Swiss Re calculation 12
Intra and Inter model risk A comparison using 99th percentiles at run-off of the two tested models of a level annuity at age 65 and 80 (interest rate of 4%) % of PV of Annuity payments Age 65 Age 80 Intra-model variation 5-9% 6-11% Inter-model variation 9% 10% Implied Standalone Capital Requirement 10-12% 11-14% Solvency II QIS 5 Stress 5-6% 10-11% Swiss Re calculation 13
Netherlands improvements 1968-1992 Source: Centraal Bureau voor de Statistiek data, Swiss Re calculation 14
NL improvements 1968-1992 Projected to 2011 Source: Centraal Bureau voor de Statistiek data, Swiss Re calculation Projection from 1992, Lee Carter Model with cohort term (M3 in Lifemetrics) 15
NL improvements1968-2011 Actual Source: Centraal Bureau voor de Statistiek data, Swiss Re calculation 16
Smoking cessation key driver of mortality improvements Source : OECD StatExtracts data 17
International trends in males mortality: Mexico slower drop than other countries on cardiovascular deaths Source : WHO data 18
Trends in obesity: Mexico increasing prevalence Source : OECD StatExtracts data 19
Mexico - obesity leading to increases from causes such as diabetes, males age 55-74 Source : WHO data 20
Complex interaction of social, behavioural and environmental factors driving disease burden Figure 1 highlights the large range of type 2 diabetes prevalence's even within the same or similar ethnic groups, when living under different conditions. Clearly many of the difference between these rates reflect underlying behavioural, environmental and social risk factors, such as diet, level of obesity and physical activity. Source : Diabetes and Impaired Glucose Tolerance, By Richard Sicree, Jonathan Shaw, Paul Zimmet Baker IDI Heart and Diabetes Institute 21
Social burden of obesity: UK prevalence skewed to most deprived Source : Health Survey for England 2006-2010 22
Social burden of obesity: USA by education less clear evidence for distribution by social class Source : CDC/NCHS National Health and Nutritional Examination Survey 2005-2008 23
Government responses so far muted: Will more effort be made in the future? 24
Longevity modelling behind other disciplines Actuarial subjective projections Actuariallyadjusted historic projections Stochastic modelling Interdisciplinary cause-based projections Maturity of development Longevity modelling Natural perils modelling 25
Period life expectancy at age 65 Mortality trend is systematic in nature (no diversification from volume or geography) Source: OECD StatExtracts, 26
Period life expectancy at age 65 Mexico is an outlier Source: OECD StatExtracts, 27
25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 Mortality risk as a hedge for longevity risk? Exposure to cohort differentials Longevity risk is the risk that people live longer than expected Mortality risk is the risk that people die sooner than expected Typical age distribution of pension fund Typical age distribution of pension fund Age Typical buyers of of life life products Mortality Exposure Longevity Exposure Net Exposure 28
Mortality risk as a hedge for longevity risk? Causes of death vary by age 100% % Male deaths by age (2007), Latin America 90% 80% 70% 60% 50% 40% 30% 20% 10% Cancers Circulatory Respiratory Accidents Suicide/Homicide Infectious Others 0% 20-24 years 25-29 years 30-34 years 35-39 years 40-44 years 45-49 years 50-54 years 55-59 years 60-64 years 65-69 years 70-74 years 75-79 years 80-84 years Age 85+ Source: WHO database, ICD10 file. Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela included. 29
Creating a Longevity Risk Market 30
Catalysts for risk transfer Motivated buyers and sellers Risk transfer Credible, timely and consistent data Well-understood and widelyaccepted risk models 31
Annual pension payments How does a longevity swap work? Scenario 1: Net difference paid by the insurer to the pension plan Annual premium leg Scenario 1: Illustrative increased annual pension payments if longevity gets longer Scenario 2: Illustrative lower annual pension payments if longevity gets shorter Scenario 2: Net difference paid by the pension plan to the insurer 2010 Certainty Pension plan liability is the annual premium payment regardless of changes in longevity Swap Format Insurer covers the cost if longevity increases, and gains if longevity decreases 32
Annual pension payments Cost of longevity insurance Insurance premium for longevity insurance Catch-up premium Actual cost Perceived cost Realistic pension reserving for longevity Pension plan current reserving for longevity 2010 In the UK, the prudence margin typically offsets much of the cost. Decision therefore is whether to use the prudence margin, plus perhaps a little more, for certainty 33
Mexico Mortality improvement males: Historic fit to 2009 and regulatory projection Projection Actual Source : History, Consejo Nacional De Población data, Swiss Re Calculation Projection, CNSF, http://www.cnsf.gob.mx/normativa/paginas/acus2011.aspx 34
Mexico Mortality improvement females: Historic fit to 2009 and regulatory projection Projection Actual Source : History, Consejo Nacional De Población data, Swiss Re Calculation Projection, CNSF, http://www.cnsf.gob.mx/normativa/paginas/acus2011.aspx 35
USA Mortality improvements & Scale AA Projection AA Actual Source: Human Mortality Database (Historic Data), society of Actuaries (AA Scale) Slide 36
USA Mortality improvements scale AA Mortality Improvements - 1930's Birth Cohort 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020-1.0% Observed Raw AA Observed Smooth Source: Human Mortality Database (Historic mortality data), Society of Actuaries (AA scale) 37
UK mortality improvement: Historic fit to 2010, CMI model projection to 2020 Projection Actual Source : Human Mortality Database data, Swiss Re Calculation 38
Period and cohort life expectancy age 65: Mexico lower levels of improvement expected Source : Tabla De Tasas De Mortalidad De Activos Para La Seguridad Social, 2009, EMSSAH-09, CNSF, CMI, Society of Actuaries improvement data, Swiss Re Calculation 39
Finite capacity, disproportionate demand UK corporate pension liabilities Over GBP 1 trillion Proportion of UK corporate pension liabilities insured each year Under 1%pa UK Life Companies Annuity reserves GBP 150bn Although the bulk annuity market is growing, activity is still small in comparison to the total pensions market Over the last 5 years GBP 30 billion of pension liabilities has been transferred through bulk annuity and longevity hedging There is insufficient capacity in the insurance market to absorb the future demand for longevity risk transfer from UK pension plans 40
2013 2012 2011 2010 2009 UK corporate pension scheme transactions RSA GBP 1.9bn Goldman Sachs Reinsurance Market Babcock International GBP 1.2bn Credit Suisse Reinsurance Market Royal County of Berkshire GBP 1.0bn Swiss Re BMW GBP 3.0bn Deutsche Bank Reinsurance Market British Airways GBP 1.3bn Goldman Sachs Reinsurance Market ITV GBP 1.7bn Credit Suisse Reinsurance Market Rolls-Royce GBP 3.0bn Deutsche Bank Reinsurance Market British Airways GBP 1.3bn Goldman Sachs Reinsurance Market Pilkington GBP 1.0bn Legal & General Reinsurance Market AkzoNobel GBP 1.4bn Swiss Re LV= GBP 0.8bn Swiss Re BAE Systems GBP 3.2bn Legal & General Reinsurance Market Bentley Motors GBP 0.4bn Deutsche Bank Reinsurance Market 41
Evolution of longevity market Indemnity based Named lives matches exposure of risk holder Extensive due diligence and disclosure requirements Bespoke, limited scope for liquid, secondary trading market Appeal to narrow range of investors, e.g. specialised Insurance Linked Securities funds Index based Linked to publicised mortality index, e.g. general population Risk holder retains basis risk between own portfolio and index Standardised, scaleable, more suited for secondary trading Likely to appeal to wider investor base, e.g. money managers and multi-strategy hedge funds 42
Capital markets favour credible, timely and frequent data In terms of frequency and granularity there is scope for improvement Available in the UK Not available Annually Aggregate total deaths Aggregate age-grouped deaths Aggregate individualage deaths Geographical age-grouped deaths Causal age-grouped deaths Quarterly Weekly Timeliness is key in data collection for parametric Eurowind bonds Timeliness The recent move by the ONS to reporting deaths as they are registered reduces reporting lag Governance An independent agent with an explicit mandate to calculate and maintain indices is essential 43
Develop capital market investor base Kortis example Swiss Re has entered into a transaction with Kortis Capital Ltd. ("Kortis") to receive up to $50m of payments in the event of a large increase in the differential in mortality improvements between male lives aged 75-85 in England & Wales and male lives aged 55-65 in the US First tradable rated security providing protection against longevity trend risk Trigger is based on a longevity divergence index measuring mortality improvements in England & Wales relative to mortality improvements in the US Management Highlights "Swiss Re's longevity strategy focuses on providing our clients with indemnity protection, while supporting the development of efficient capital market solutions on an indexed basis as a source of future long-term capacity Brian Gray, Chief Underwriting Officer, Swiss Re "The Kortis programme is of particular note as it provides protection against adverse deviation in mortality improvements for both Swiss Re s mortality and longevity portfolios, whilst taking into account the complementary nature of the two risks Christian Mumenthaler, Head Life & Health, Swiss Re 44
Conclusion 45
Conclusion Understanding longevity risk continues to be a challenge for both buyers and sellers of risk Historic models have failed need for forward looking cause based models Longevity risk is systematic scale and portfolio diversification of limited use as risk mitigation tools Risk capital in the insurance industry can carry only a small proportion of longevity risk Reinsurers providing some new capacity Capital Markets solutions required to provide large enough pool of capital to carry the risk, however still early days Recent Mexican mortality experience an outlier in international comparisons will this trend continue or reverse? 46
Thank you For further information please contact: Torben Thomsen torben_thomsen@swissre.com + 44 207 933 4530 Luis Francisco Galvan luis_galvan@swissre.com +52 55 5322 8328
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