Converting Longevity risk into an asset

The seventh annual Longevity Risk and Capital Markets Solutions Conference held at Goethe Universíty in Frankfurt last week generated a buzz around converting the longevity risk into asset.

It is done by creating slices or tranches by the levels of risk posed and have someone buy them. The buyer gets a stream of income (premium share) in exchange for a consideration, one time fixed or another stream of fixed income. Reinsurance is a bit close to this. It is similar to CDS, the reference entity here being the annuitants as a class, and the "default" here is the longevity beyond product design assumptions (or even contract specifcations).

Tom Armistead in his seekingalpha.com column mentions, "Insurance companies or pension funds that have an excess of longevity risk can create insurance policies to protect and hedge themselves. The policies, which will entail a flow of premiums, can then be sold as assets, with the premiums masquerading as dividends, thereby unloading longevity risk.

Longevity may take a long time to manifest itself. As such, the opportunity of packaging and selling the risk will be ongoing. The so-called assets may exhibit rock solid performance for years.".

But who will be ready to take the long position of the synthetic asset? Reinsurers? And what all the considerations for that - Medical Underwriting at annuitization? And how would the buyers hedge their risk of being out the money?

Interesting aspects to consider.

Regulations and Regulators

In an Exposure Draft on Pension Products published yesterday, IRDA has relaxed its earlier requirement that all pension products should ensure an accumulation at a rate of 4.5% which was also indexed to the Reverse Repo Rate of the RBI. This has now been relaxed citing the uncertainty in investment returns.

Now the requirement is that an assured benefit in absolute terms should be specified at the time of sale, which would be payable at the vesting date. Alternatively a guaranteed return of premiums or a guaranteed annuity on vesting date could be mentioned.

Will this ease the pressure on LIC Pension funds which were pilloried due to notional loss? Only subsequent reporting will help us know. Will this stimulate other insurers to launch new pension products? Let's hope so.

Where is PFRDA in all this?

Imported wine in a new goblet?

On Monday 20th of June 2011,  the Bank of England and Financial Services Authority published a joint paper titled 'Our future approach to insurance supervision'

The to be formed Prudential Regulatory Authority (PRA) has among its objectives:

• Protection for policyholders
• Protection of the system from individual Insurer failures

Sales Suitability will be monitored by Financial Conduct Authority (FCA).

In the introduction section of the paper, among other things, FSA speaks of inadequacy of reserves as a recurring theme in past organizational collapses like Equitable Life (2000) and AIG (2009). But is it the adequacy of the reserves or the approach to investment of the reserves that should be looked at? Hope the underlying aim is that of a principle based regulation rather than a rule based one.


The report also details a Risk Assessment Framework with eight areas of evaluation of the risk viz., Impact of the firm on the policy holders and the system, External context, Business risks, Operational risk controls, Risk Management and governance, Financial Liquidity, Capital and Resolvability (Closing down). Stress testing, Audit, are mentioned as ways to assess the evaluation criteria.


I am not seeing anything ground breaking here. I am left wondering whether the AIG type of collapse can still happen under the proposed structure.

We don't want to learn from experience!!

In a Hearing before the House Financial Services Committee on June 16, 2011, Barry Zubrow, Chief Risk Officer, JPMorgan Chase & Co. uttered the following:

"None of the world’s five largest banks is a U.S. bank. U.S. banks represent 24 percent of the market share of the 50 largest global banks, down from over 50 percent only eight years ago; Chinese banks now hold 22 percent.
.........
If large U.S. banks are hobbled by uneconomic capital levels or risk restrictions, a U.S. company is not going to turn to smaller U.S. banks to underwrite a €1 billion debt offering paired with a euro/dollar swap, or to lend it $200 million, or to provide custody services for a new overseas subsidiary; rather, it is going to turn to our foreign bank competitors."

He was articulating that regulation is going too far.
I guess it is forgotten that eight years ago, the regulations were not as much as it is now. Even with the lower than current level of regulations that were existing the US banks managed to bring down their importance in terms of market share. It looks like Barry is arguing against his own case!!
Reading the full testimony is surrealistic. It can be found here - http://online.wsj.com/public/resources/documents/ZubrowHFSC.pdf

Assessing Systemic Risk

In the US, the Financial Stability Oversight Council (FSOC) on 18^th January, 2011,  approved a proposal laying out six factors that regulators would use to determine if non-bank financial firms like hedge funds, insurance companies, broker-dealers and specialty finance companies threaten to destabilize the U.S. financial system. The factors that regulators would potentially consider include: size, the dominance of a firm in its industry, interconnectedness, use of leverage, liquidity risk, and the existing degree of oversight on the firm.   Under the FSOC’s proposed rule, if designated, the largest, most interconnected and highly-leveraged companies would face stricter prudential regulation, including higher capital requirements and more robust consolidated supervision.

On the face of it, this looks a bit opposite of what a regulator should be trying to do: To see how Insurers (and others as well) would weather systemic risk scenarios; while the FSOC says it is trying to determine the extent which the individual companies can destabilize U.S. Financial system, i.e., cause systemic risk.

From the proposal:

The Council proposes to use a framework for applying the statutory considerations to its analysis.(..) If adopted in a final rule, this framework would be used by the Council in meeting its statutory obligations of assessing the threat a nonbank financial company may pose to the financial stability of the United States. The proposed framework for assessing systemic importance is organized around six broad categories. Each of the proposed categories reflects a different dimension of a firm’s potential to experience material financial distress, as well as the nature, scope, size, scale, concentration, interconnectedness and mix of the company’s activities. The six categories are as follows:

1. Size;

2. Lack of substitutes for the financial services and products the company provides;

3. Interconnectedness with other financial firms;

4. Leverage;

5. Liquidity risk and maturity mismatch; and

6. Existing regulatory scrutiny

Each of the specific statutory factors is relevant to, and would be considered as part of, one or more categories within this analytical framework. In addition, the Council would consider any other risk-related factors that the Council deems appropriate, either by regulation or on a case-by-case basis, (..) in accordance with this analytical framework.