Longevity risk transfer Cord-Roland Rinke, L&H Longevity

Transcription

1 Cord-Roland Rinke, L&H Longevity BVZL-ELSA Life Settlement Summit 2014 Munich, 29 September

2 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Disclaimer This presentation does not address the investment objectives or financial situation of any particular person or legal entity. Investors should seek independent professional advice and perform their own analysis regarding the appropriateness of investing in any of our securities. While Hannover Re has endeavoured to include in this presentation information it believes to be reliable, complete and up-to-date, the company does not make any representation or warranty, express or implied, as to the accuracy, completeness or updated status of such information. Some of the statements in this presentation may be forward-looking statements or statements of future expectations based on currently available information. Such statements naturally are subject to risks and uncertainties. Factors such as the development of general economic conditions, future market conditions, unusual catastrophic loss events, changes in the capital markets and other circumstances may cause the actual events or results to be materially different from those anticipated by such statements. This presentation serves information purposes only and does not constitute or form part of an offer or solicitation to acquire, subscribe to or dispose of, any of the securities of Hannover Re. Hannover Rück SE. All rights reserved. Hannover Re is the registered service mark of Hannover Rück SE. 2

3 Agenda Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up

4 Introduction

5 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Life Expectancies for 65 year old in the UK Development over time Life expectancies and annuity factors in the UK (both sexes) in years LE NPV Source: own calculations using HMD-data and 2% interest 4

6 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Longevity and Pension Markets Assets in the Pension Market Assets in tn. USD , , ,12 2,74 0,19 0,50 Source: Towers Watson: Global Pensions Asset Study 2013 Global pension assets now amount to 78.3% of the GDP of above economies 5

7 Longevity Risks

8 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Different kinds of Longevity risk Today s mortality Experience Analyses give an indication of today s mortality for a specific portfolio Detailed analyses are only possible where enough data is available; hence, socioeconomic patterns might be overlooked for smaller portfolios Future mortality: improvements are very volatile and there are many different opinions on how mortality improvements will develop in the future Ancillary Benefits: Spouse pension, escalations, commutations, etc. Micro longevity risk: Longevity risk concerning the specific longevity of individuals considering the individual s age, health status, lifestyle etc.; focus is on individuals Macro longevity risk: Longevity risk concerning the longevity of large collections of individuals considering the group s past and present mortality and the changes in future mortality; focus is on common determinants of current and future mortality model 8

9 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Who can manage which risks? Pension schemes Regulatory changes Data Mortality risk Systematic Unsystematic Investment risk Ancillary benefit Insurer / Reinsurer Level Shape Stochastic Spouses Special benefits Capital Market/ Investor Asset risks Benefit inflation Improvement Seasonality 9

10 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Holders of Longevity Risks Many developed countries have a pension system consisting of State pension Government/Communities Occupational pension Employers/Corporates Private pension Life Insurers Corporates and pension funds seek to lay off parts of their risks inherent in the liabilities P&C Insurers hold longevity risk from Structured Settlements Investors hold longevity risk from Life Settlements Substantial longevity risks currently held outside the insurance industry 10

11 Mortality Improvements

12 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Improvement decomposition Effects by way of example USA males Improvement components for males in the USA Period component Age component Cohort component 12

13 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Modelling mortality improvements The Age-Period-Cohort Model Model for mortality improvements i( x, t) = a( x) + b( t) + c( t x) Age component Period component Cohort component This model is called Age-Period-Cohort model (APC model) and is the basis for projecting mortality improvements 13

14 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Correlation of mortality improvements Different countries - different patterns? Comparison of age components W. Germany / USA / UK West Germany USA UK 14

15 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Correlation of mortality improvements Different countries - different patterns? Comparison of age components W. Germany / USA / UK in % 1,0% 0,8% 0,6% 0,4% 0,2% 0,0% -0,2% -0,4% -0,6% -0,8% -1,0% W. Germany USA UK 15

16 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Correlation of mortality improvements Different countries - different patterns? Comparison of period components W. Germany / USA / UK West Germany USA UK 16

17 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Correlation of mortality improvements Different countries - different patterns? Comparison of period components W. Germany / USA / UK in % 3,5% 3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% ,5% ,0% W. Germany USA UK 17

18 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Correlation of mortality improvements Different countries - different patterns? Comparison of cohort components W. Germany / USA / UK West Germany USA UK 18

19 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Correlation of mortality improvements Different countries - different patterns? Comparison of cohort components W. Germany / USA / UK in % 2,0% 1,5% 1,0% 0,5% 0,0% ,5% W. Germany USA UK -1,0% -1,5% -2,0% 19

20 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Correlation of mortality improvements Different countries - different patterns? Comparison of total annual improvement W. Germany / USA / UK West Germany USA UK 20

21 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Trend projection using the CMI_2013 tool Sample projection Historic and projected trend for males in the UK 21

22 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Longevity Swap - The Technical Model Pension Scheme Transaction Monthly payment for life Pensioner Cedant Expected annuity payment + fee (fixed leg) Actual annuity payment (floating leg) Proportional reassurance agreement typically a quota share Hannover Re pays actual annuity benefits for reassured business Hannover Re Hannover Re receives regular reinsurance premium equal to expected annuity payments plus a fee, fixed at inception based on best estimate mortality and mortality improvements Net settlement of cash flows Protection from the financial impact if pensioners live longer than expected 23

23 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Longevity Swap Swapping expected and actual cash flows Sample cash-flows for longevity swap Actual payments Expected payments (fixed leg) premium+fee (floating leg + fee) Extended LE Shortened LE 24

24 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Longevity Swap Swapping expected and actual cash flows Sample cash-flows for longevity swap Actual payments Expected payments (fixed leg) premium+fee (floating leg + fee) Extended LE Shortened LE 24

25 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Longevity Swap Swapping expected and actual cash flows Sample cash-flows for longevity swap Actual payments Expected payments (fixed leg) premium+fee (floating leg + fee) Extended LE Shortened LE 25

26 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Longevity Swap Swapping expected and actual cash flows Sample cash-flows for longevity swap Cedant receives difference, if >0 Reinsurer receives difference, if >0 Actual payments Expected payments (fixed leg) premium+fee (floating leg + fee) Extended LE Shortened LE 26

27 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Contractual agreement Important considerations Exact definition of the covered benefits and the price structured fee versus flat fee Treatment of data errors recalculation of fixed leg, price adjustments Initial data cleaning Administration and minimum standard requirements Collateral provisions Termination provisions 28

28 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Market Volume for Pension Block Transactions in UK Treaties closed Buy-Outs, Buy-Ins and Longevity Swaps in bn. GBP only H1 Longevity Swap Buy-In/Buy-Out Source: LCP Pension Buy-Ins, Buy-Outs and Longevity Swaps , current market data for 2014 from 29

29 Derivatives

30 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Value hedge versus cash-flow hedge Direct and indirect hedges Value hedge: hedge against an asset / liability with a fixed value that changes according to supply and demand Cash-flow hedge: hedge derived from cash flows received from two or more financial products Both hedges are used to hedge against changes in the value of the asset The cash-flow hedge is linked to an asset/liability that provides regular payments to/from the holder Direct hedge: hedge in which the cash market instrument being hedged is hedged by an options or futures contract on the same underlying instrument Indirect hedge: hedge based on a parameter influencing index that should actually be covered 31

31 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Index solutions Forwards q-forward: capital market instrument for transferring longevity or mortality risk Involves the exchange of realized mortality rate of a population at some future date, in return for a fixed mortality rate agreed at inception q-forwards form the basis from which many other more complex derivatives can be constructed S-forward: cash settled contract linked to survival rates of a given population Basic building-block for longevity swaps used by pension funds and (re)insurers Swaps essentially comprise a stream of S-forwards with different maturity dates Also referred to as the tpx-forward 32

32 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up S-forwards for Life Settlements Value hedge, directly hedging survivorship rate The investor s return in life settlements depends on time to payment of the sum assured. Ensuring payment of the sum assured at a specific date secures IRR Index based coverage against longevity risk in a Life Settlements portfolio: construct S-forward Pay premium (fixed leg) according to the expected value (notional) of the portfolio and a given date (tenor), notional equal to sum assured (less premiums) Receive floating leg according to the actual sum assured for the given portfolio at the given date This construction allows to hedge the systematic risk of longevity, but not the unsystematic risk of an individual 33

33 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Index Solution Example Mortality Forward Ceding Company (Seller) Floating Notional x Realised mortality rate Fix Notional x Strike rate Reassurer (Buyer) Buyer pays Strike rate Net Settlement at end of tenor Floor Cap Realised index mortality Seller pays 34

34 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Mortality Forward Typically indirect value hedge Pay-out structure mortality forward Tenor Pay-out (strike rate less realised mortality rate) mortality No basis risk transferred, only systematic risk Strike rate During the lifetime of the contract an index is published Mortality rate higher than expected: seller has to pay, mortality rate lower than expected: buyer has to pay Fixed limited duration of trade Might be attractive due to savings in the cost of capital, although the cover is quite expensive 35

35 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up EIB / BNP Longevity Bond (never sold) Setup and problems Announced in 11/2004 and attempted to issue by the European Investment Bank BNP Paribas was the originator, the longevity risk was reinsured 540 million, 25 year maturity (may be too short) Amortizing bond Floating coupon payments tied to cohort survivor index (English and Welsh males age 65) Required upfront payment by hedgers Cost to hedge ~20 basis points Credit risk (bank, reassurer) Cross-currency interest-rate swap between EIB and BNP involved: EIB pays floating euros and receives fixed sterling Intended to be an indirect cash flow hedge 36

36 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Other capital market transactions Recent activities in the market Kortis (2010) International Bank for Reconstruction and Development issued longevity trend bond of USD 50 million Duration 8 years Covers improvements experienced by older UK males against younger US males Indirectly hedging the value of the correlation Pall UK Pension Fund (2011) JP Morgan takes on GBP 70 million of risk of improving longevity 10-year term in which the fund s trustees can choose to adjust size or structure of the deal If the life expectancy improves at a greater rate than specified in the contract the fund receives an insurance payout Indirect value hedge 37

37 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Other capital market transactions Recent activities in the market Pandemic Bonds Vita Cat Bonds (2003, 2005, 2006) Nathan (2008) AEGON / Deutsche Bank longevity transaction (2012) Based on Dutch population data one of the first longevity deals outside of the UK Applied to a synthetic portfolio Enables Aegon to hedge the liabilities on a portion of their book of annuities Delta Lloyd in EUR 12 billion (?) index-based longevity swap with Reinsurer (2014) 38

38 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Possible Index solution to hedge future value 39

39 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up LLMA Life & Longevity Markets Association Aim: liquid traded market in longevity and mortality-related risk LLMA index (launched in 2012) Mortality rates and period life expectancy for U.S., England & Wales, the Netherlands and Germany Sample term sheets for q-forwards and S-forwards Longevity Pricing Framework 41

40 Life Settlements

41 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Life Settlements An overview Life Settlement: sale of an existing life insurance policy to an investor for more than its cash surrender value, but less than its net death benefit The third party pays the premiums and has the right to lapse surrender sell the policy to another party package the policies and sell them to In case the original beneficiary dies and the policy is still in force, the benefit goes to the investor But: investor can run out of money to pay premiums 43

42 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Life settlements versus pension funds Life Settlements Life Expectancies are assessed individually individual health status is important Expectation of income return from Investors (Minimum) premium must be paid to keep in-force A number of options available to the investor Index-covers: Index usually built from a concrete portfolio of life settlement policies Pension/annuity risks Very long periods Life Expectancies of individuals not very relevant (could be tens of thousands of beneficiaries) Index-covers: Index covers usually take population mortality into account rather than a concrete portfolio Essentially no options available 44

43 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Life settlement covers Specific covers LE+2 cover: Offered by Goshawk Syndicate in the early noughties Upfront premium (Re)insurer buys policy from the investor at its face amount in case the underlying life survives two years longer than expected at purchase (contingent cost insurance) Payment to Goshawk limited to premium Yield Collar Stop Loss (per policy) Ensures yield of life settlement policy to remain within predefined range (minimum yield to maximum yield) Reassurer benefits from early deaths Reassurer assumes policy as salvage when minimum yield is reached Offers upside and downside for both parties 45

44 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Life settlement covers Aggregate covers On an aggregate basis Similar to swap Exchange fixed and floating legs Swap Sum assured Premiums Stop Loss cover Upfront premium Payments are made based on the number of survivors at a predefined point in time in the future Reassurer pays if number of survivors exceeds a threshold Amounts weighting (e.g. sum assured) possible 46

45 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Life settlement covers Synthetics Principle-at-risk bond Index created from mortality on underlying portfolio of life settlements Invest in life settlement and hedge some of the risk (indirect value hedge) Sell bond with principle based on index Principle reduces as more insured lives survive Overhedging/speculation possible by selling more bonds than the seller is exposed to Variants Only gain right to track lives in a portfolio and speculate on the performance of the bond Overhedging/speculation possible by selling more bonds than the seller is exposed to 47

46 Wrap up

47 Introduction Longevity Risks Mortality Improvements Reinsurance Swap Derivatives Life Settlements Wrap up Wrap up Volume of Longevity market increases steadily over time Pensions/annuities: New products emerge, partially requiring a very detailed understanding of the key drivers of mortality Longevity Swap is standard reinsurance products in the UK: Direct cash flow hedge covering all risks (systematic and unsystematic) Some index solutions have already been signed and many more are currently in development Life Settlements: Popular not only in the US, but also in large parts of Western Europe and Japan, mainly outright sale or non-proportional covers Basis risk (unsystematic risk) much more relevant Index solutions more prevalent, index refers to specific portfolio (basis risk transferred) 46