The marketing fraternity would have us believe senior citizens enjoy a Golden Age.
But anyone who has been there knows better. Growing old is a horrible business, right? It is about incremental humiliation and disappointment which must be endured or hidden as the world prefers to focus on things new and fresh and young.
However, this week marks the opening of a new playground for decrepitude. Longevity risk!
Who would think that could be packaged with a smile? Gather round to hear how living longer and all its associated pain can offer all investors – even the very young – an exciting, profitable and socially useful function.
Here is the good news up front. It is a huge market, right here in the UK, at the very start of a long and volatile evolution. It is complex, ever-changing, difficult to value and over the counter, offering fantastic opportunities for securitisation, mis-pricing, arbitrage and leverage. Sound familiar? Not since the birth of collateralised debt obligations has the financial sector relished such opportunity.
Official UK stats show that between 1981 and 2002, life expectancy at age 50 increased by four and a half years for men and three years for women. Excellent: life should be celebrated. But that extension is striking terror into the investment committees of pension funds and life firms.
They suspect, probably correctly, that the actuarial calculations are already out of date and that their liabilities are rather understated.
So the trend for pension schemes to farm out longevity risk (but not the underlying investment risk) as quickly as they can to specialist managers with insurance pedigrees has been gathering pace. Now the business needs to explore the wider capital markets.
Longevity swaps cover pension funds against the risk that their members live longer than expected. It is related to the booming but slightly different life settlement market, which clocked up around $12bn in 2008, up from just $2bn in 2002. Mortality risk, another related market, covers catastrophic risk such as lethal epidemics – like swine flu.
A trade body, the Longevity and Life Markets Association (LLMA), has just been launched, with founder companies Axa, Deutsche Bank, J.P. Morgan, Legal & General, Pension Corporation, Prudential, RBS and Swiss Re. This is perfect timing. A few early deals have been done successfully, amounting to just 1% ($20bn) of a market thought to be worth some $2trn in the UK alone. Membership of the LLMA is expected to expand rapidly.
The UK-based association will set up proper protocols, based on those for interest rate and inflation swaps, to ensure the longevity risk market runs as smoothly. Standardised documentation will create capacity and underpin liquidity. A couple of longevity funds have already tested the water, and found it warm and inviting. No wonder, here is a genuine diversification opportunity, with no correlation to other markets, with a paucity of data, necessitating the use of lots of modelling and algorithms. Its playtime again!
As the market gets going in the UK, pension funds in the Netherlands are already showing strong interest. And why not – they face identical problems and challenges. But they would want their risk priced in euros. So another dimension to exploit: currency classes. No wonder the hedge funds are hovering shyly at the sidelines along with the usual life funds and long only fixed income managers.
Firms like Credit Suisse, Goldman Sachs and J.P. Morgan have been running longevity indices for a while, but players have been looking for something with a Sovereign stamp on it. Following some well placed lobbying, a recent UK Treasury missive conceded that HMG is prepared “to study” the longevity risk market.
To study it, surely, is to contemplate the possibility of issuance into it. Which would be wonderful. Because no-one wants short dated gilts any more, and there is not much to buy at the long end. A longevity-linked gilt issue of venerable duration would be a very public-spirited gift to the markets, just as soon as the General Election, that little local difficulty, is out of the way.
