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New longevity risk methodology developed for insurers and pensions schemes

Research produces new framework for insurers and pension schemes to assess longevity risk

• Research produces new framework for insurers and pension schemes to assess longevity risk

• Applicable to insurers under Solvency II and integrated risk management of pension schemes

• Index-based hedges have considerable potential to provide effective risk and capital management for all holders of longevity risk

• More accessible risk management for smaller pension schemes and insurers through index linked longevity swaps

An Institute and Faculty of Actuaries (IFoA) and Life and Longevity Markets Association (LLMA) jointly commissioned research project has today published a novel readily-applicable methodology allowing insurers and pension schemes to assess Longevity Basis Risk. This ground-breaking work, carried out by a joint research team from Hymans Robertson and Cass Business School, will enable the use of simpler, more standardised and easier to execute index-based longevity solutions. There are also broader applications for insurers and pension funds in managing their capital requirements relating to longevity risk.

Index-based longevity swaps allow pension schemes and insurers to offset the risk of increased liabilities resulting from members living longer than expected. Until now, it has been difficult to assess how well the index-based longevity swap can reduce the longevity risk for the particular pension scheme or insurance book. The methodology developed in this research advances the thinking on how this is assessed. The framework has been designed to be applicable to both large schemes (which can use their own data in their models) and smaller schemes (by capturing demographic differences such as socio-economic class and deprivation).

While the cost and complexity of longevity swaps means they have often been the preserve of large schemes, this research could make longevity swaps more accessible to smaller schemes and insurers in managing longevity risk. The development has the potential to transform the £10Bn per annum longevity swap market, opening it up to those for whom the current bespoke solutions have not proved appropriate. It is predicted that this work could provide the catalyst for growth in the still nascent market.

Nick Salter President of the Institute and Faculty of Actuaries commented:
"Understanding and managing longevity risk is a key challenge for pension funds and life insurers. As a thought leader in the longevity field the IFoA, together with the LLMA, saw a need for a practical methodology underpinned with robust academic research. We are delighted with the outcome of this research and see application for insurers with Solvency II and integrated risk management for pension schemes, as well as for any transactions they may undertake in the longevity swap market."

Daniel Ryan, spokesperson for the LLMA welcomed the research, saying:
"This is a significant moment for the pensions and insurance industry. The LLMA has co-sponsored the research because we believe in the need to de-mystify longevity basis risk analysis and to provide a practical solution which will enable greater longevity risk transfer to the capital markets."

Andrew Gaches, partner at Hymans Robertson commented:
"Longevity swaps have proved an excellent innovation, but their typical bespoke structure does not provide a solution in all cases.
"Index-based solutions provide a simple and effective answer to this problem. Our hope is that this this work will enable many more schemes and insurers to better understand their risks and more effectively hedge against them, enabling the uptake of index-based longevity swaps and turning them mainstream.
"We are delighted to publish our findings and make this contribution to the democratisation of the longevity swap market."

Professor Steven Haberman, Dean of Cass Business School, and co-author of the research, said:
"We have developed a simple and easily applicable methodology for measuring and quantifying longevity basis risk.

"Longevity basis risk arises because different populations have different survival rates and hence longevity and life expectancy. Our methodology focuses on the demographic and socio-economic differences between a national population and a pension scheme or annuity portfolio, and how these differences in turn affect longevity.

"The findings will help insurance and pensions providers to use national population-based mortality indices to manage longevity risk in pension schemes and annuity portfolios.

"We hope the research helps companies to more effectively set annuity prices and meet their regulatory requirements. We also hope it leads to the further development of the longevity swap market which will help transfer risk to the reinsurance and financial markets."

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