Live long and prosper … possibly, given a bit of risk management
3 Jun 2010:
Just when we were getting used to Liquidity Risk as the new risk on the block, along comes another. Longevity Risk is defined as the risk that people will live longer than expected and given it is asserted to be one of the largest risks pension funds bear (as it increases the amount of pension these “longer livers” claim), it has had greater publicity over recent months. Unlike investment risk, longevity risk is not rewarded with any return for the investment firm, and unlike interest rate risk, it cannot easily be hedged. Current ways of hedging this risk rely on bespoke methods and individual arrangements which in turn make the widespread adoption of hedging techniques difficult. Despite this, the FT estimates that almost $10bn of longevity risk transfer business has been done over the last 18 months.
However, the lack of standardisation may be about to change. A number of major institutions are now getting together in the UK to form the Life and Longevity Markets Association. This new association is tasked with getting better defined hedging products and standards which would make for easier and more liquid trading in these risk products. This initiative has been created initially in the UK due to regulatory pressures. However, some commentators are worried that standardisation could lead to use of securitisation techniques, which were part of the cause of the sub-prime crisis. Hence given the size of the Longevity Risk market the consequences of any market or regulatory failure could be even more damaging. Hence, this growing market needs to be well labelled “Handle with Care”.
This article was originally published in the MPI Europe FS Bulletin. To receive this bulletin each month simply sign up HERE on LinkedIn
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