Ultra long term financial instruments

Transcription

1 Ultra long term financial instruments Jens Thomsen OECD Seminar: The pension payout phase: annuities and implications for financial markets Paris, 12 November 2008

2 DANMARKS NATIONALBANK 2 Prologue I have two messages for you today: The positive news is that people today live longer than ever before At the same time they may outlive their reserves and may at some point need to reduce their standard of living

3 Old-age dependency is rising sharply Age distribution Asia % % Europe % North America (%) (%) 65 or over (%) Source: United Nations DANMARKS NATIONALBANK 3

4 Longevity risk is the risk that individuals will live longer than statistically expected Years 82 Life expectancy at birth Advances in health care, nutrition and sanitation have increased life expectancy Nordic count ries EU-15 USA Source: OECD DANMARKS NATIONALBANK 4

5 In particular, the increase in life expectancy at retirement age can be a challenge for carriers of longevity risk Years Life expectancy at age of Nordic countries Males EU-15 Males US Males Nordic count ries Females EU-15 Females US Females Source: OECD DANMARKS NATIONALBANK 5

6 The risk is the speed and magnitude of the change in life expectancy, not the direction Expected and unexpected development in life expectancy for women in Denmark Age Uncertainty can be toxic for pension funds Upward trend -challenging but manageable life expectancy including projections 95-percent fractile 5-percent fractile DANMARKS NATIONALBANK 6

7 (In)accuracy of mortality assumptions Actual and projected life expectancy at birth, UK males, Source: Shaw, C., 2007: Fifty years of United Kingdom Population projection: How accurate we have been?, Population Trends, 128, Office of National Statistics DANMARKS NATIONALBANK 7

8 DANMARKS NATIONALBANK 8 Individual s point of view Live longer How much longer? Work longer How much longer? Requires a labor market reform Save more How to save? Is there assets that are enough longdated? Do these assets give life-long income stream?

9 DK: Expected number of years with early retirement benefits and state pension for a 60-year-old, År med efterløn og folkepension Years with early retirement benefits and state pension År med efterløn og folkepension Political agreement on welfare Velfærdsaftale adjustment, 2006 Langsigtsniveau New Forslag proposals om fremrykning Long-term level Source: Labour Market Commission DANMARKS NATIONALBANK

10 DANMARKS NATIONALBANK 10 Risks affecting retirement saving Longevity risk Macroeconomic risks State pension Occupational Pension Defined benefit Defined contribution Private pension Government budget deficit Decline in corporate profits Inflation risk Investment risk

11 DANMARKS NATIONALBANK 11 Types of pension plans Defined benefit plan Benefit determined by a set formula Sponsor bears investment or longevity risk Defined contribution plan Benefit depends on contributed amount and investment returns Retiree bears investment and longevity risk No matter who bears the risks, instruments for investment and longevity risk bearing and hedging are needed

12 DANMARKS NATIONALBANK 12 Government bonds with maturities over 30 years, OECD-countries OVERVIEW OF LONG-TERM GOVERNMENT BONDS Country Latest maturity Nominal/Linker Austria Nominal Belgium Nominal Canada Nominal Canada Linker Czech Republic Nominal Denmark Nominal France Nominal Germany Nominal Greece Nominal Italy Linker Japan Nominal Netherlands Nominal Poland Nominal Portugal Nominal Spain Nominal Switzerland Nominal UK Nominal UK Linker USA Nominal Bubills (6 months) Source: German Finance Agency Turnover rate of German federal securities 2006 Schatz (2 years) Bobls (5 years) Inflationlinked Bund (10 years) Bunds (10 years) Bunds (30 years) Security (Maturity at issuance)

13 Markets for long-dated bonds are small relative to the size of pension fund and insurance company portfolios DANMARKS NATIONALBANK 13 USD billion USA UK France Italy Japan Corporate and government long-term bonds Life insurance investments and pension funds total assets Source: Ageing and Pension System reform, Report to the G10 deputies, 2005, Pension Markets in Focus, OECD Newsletter, Dec 2005

14 Issuance of ultra-long government bonds in UK Yield at opening: 1,112% Investors: 90% domestic. 66% fund managers, pension funds and insurance companies, 33% market makers UKDMO 22 Sep 2005 High inflation and the regulatory demands placed on pension funds continue to create solid demand for UK inflation protection from liability-driven investors Risk Magazine 1 Jul 2008 Per cent 1,20 Yield on 1.25% index-linked Treasury Gilt 2055 " The longest-dated sovereign index-linked bond in the w orld" 1,00 0,80 0,60 0,40 0,20 0,00 Due to pension regulations, UK pension funds are fighting for limited supply of longdated index-linked bonds to match the duration of their liabilities Risk Magazine 1 Feb 2006 sep- 05 dec- 05 mar- 06 jun- 06 sep- 06 dec- 06 mar- 07 jun- 07 sep- 07 dec- 07 mar- 08 jun- 08 sep- 08 Source: Bloomberg DANMARKS NATIONALBANK 14

15 DANMARKS NATIONALBANK 15 Other types of instruments for hedging longevity risk Longevity bonds (EIB project, withdrawn) Based on survivor rates Mortality linked derivatives Based on mortality rates Mortality linked securities Swiss Re and Scottish Re Asset backed securities on basis of a pool of life insurance policies

16 DANMARKS NATIONALBANK 16 Size mismatch Holders of longevity risk Pension funds and insurance companies through provision of annuities Governments through state pensions Many companies through pension schemes Buyers of longevity risk Pharmaceutical companies Care providers Asset managers

17 DANMARKS NATIONALBANK 17 A dilemma Life insurance and pension sector needs a very specific instrument to hedge specific risks (geographic and socioeconomic diversification) Investors want a standardised and liquid product

18 Hedging longevity Instrument Quality Liquid Hedge for basis risk* Hedge for specific risk Lack of correlation with other assets Ultra-long government bonds Longevity bonds Mortality linked derivatives and securities Asset backed securities on basis of a pool of life insurance policies * i.e. imperfect hedging capacity DANMARKS NATIONALBANK 18

19 DANMARKS NATIONALBANK 19 Role of the private sector Advantages Life insurance companies are experts in longevity risks Why wouldn t the natural hedgers for longevity risk issue longevity bonds? Lack of correlation between life expectancy and all other assets should appeal to a broad range of investors Barriers Hard to find a package that appeals both sellers and buyers Pure longevity risk transfer is possible only when risk is fully priced

20 DANMARKS NATIONALBANK 20 Private sector approaches in longevity hedging Self-insurance and implicit coverage Reinsurance Sale of external buyout funds

21 DANMARKS NATIONALBANK 21 What could governments do? Issue ultra-long government bonds (taking place today) Produce a reliable and widely accepted longevity index to be used as a benchmark Issue longevity bonds (more questionable)

22 DANMARKS NATIONALBANK 22 Government issuance of longevity bonds Pros: Could provide an unbiased benchmark similar to government yield curve Could be a catalyst in market development Cons: Governments are heavily exposed to longevity risk Per cent 4 3,5 3 2, Yield curve Increasing old age dependency ratio, OECD countries Age Maturity Million

23 DANMARKS NATIONALBANK 23 The end Nothing is certain in life except death and taxes. Franklin, 1789 Thank you for your attention