Creative thinking around longevity risk

(Jul 6, 2014)

The U.K. has been a hotbed of innovation when dealing with the longevity risk found in pension schemes.  Historically, schemes had the option of a traditional buy-out or buy-in policy with an insurance company (a route which may be cheaper than some people realise).  Then we saw the advent of index-based hedging, although this option has its challenges and is more of a niche market at the time of writing.  However, other innovations have shown vigorous growth, such as the market for longevity swaps.  Now the BT pension scheme (BTPS) has shown a new level of creative thinking for pension schemes: setting up your own wholly-owned insurance company so you can tap the global reinsurance market.

BTPS's move brought…

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Tags: longevity risk, regulation, longevity swaps

Longevity trend risk under Solvency II

(Jan 18, 2012)

Longevity trend risk is different from most other risks an insurer faces because the risk lies in the long-term trajectory taken by mortality rates. This trend unfolds over many years as an accumulation of small changes, so a natural approach is to calculate reserves using a long-term stress projection from a stochastic model, as shown in Figure 1.

Figure 1. Central projection from a Lee-Carter model, together with the lower 99.5th confidence level derived from multiplying the projection standard error by Z=-2.58 (this being the lower 99.5th point of the N(0,1) distribution).

Stressed projection using Z=-2.58

The stressed-trend approach behind Figure 1 can be used for a variety of models - Table 1 shows the best-estimate and 99.5th percentile…

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Tags: longevity risk, Solvency II, model risk

Sense and sensitivity

(Jul 13, 2011)

Annuities are a good example of the cornerstone of actuarial work: discounting future probabilities of payment to allow for the time value of money.  Low interest rates have had major consequences for savers looking for income in retirement, but they are also one reason behind renewed actuarial focus on longevity in recent years.

Simply put, actuaries' interest in mortality and longevity is inversely correlated with the yields obtained on gilts and corporate bonds.  This is illustrated in Figure 1.  The left panel shows how gilt yields have fallen since 1984, while the right panel shows how the cost of an annuity to a male aged 65 increases as the gilt yield falls.  The right panel shows that the fall in yields…

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Tags: Solvency II, longevity risk, longevity shock, gilt yields

Tail wags dog

(Jun 30, 2011)

Last week we looked at the odd situation whereby longevity risk is regulated more strictly in an insurance-company annuity portfolio than in a company pension scheme.  One argument for the different treatment is that the sponsoring employer is a source of ongoing financial support for the scheme.  This is not the case for annuities, where typically a single premium is handed over at outset and there is no further contribution from the beneficiary thereafter.

However, this argument only works where the scheme is small relative to the sponsoring employer. Table 1 shows a number of examples where the balance sheet of the pension scheme dwarfs the value of the sponsoring employer.

Table 1. Pension-scheme liabilities…

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Tags: longevity risk, pension schemes

Solvency II for pensions?

(Jun 21, 2011)

What is the difference between a pension and an annuity?  One simple definition is as follows:

  1. An annuity is a guarantee to pay a given sum each year until death.
  2. A pension is a promise to pay a given sum each year until death.

Casual readers could be forgiven for thinking that pensions and annuities have a lot in common, and that they should therefore be regulated in a similar manner.  After all, both annuity portfolios and pension schemes are exposed to a host of similar risks, such as increased longevity.

Despite this, the regulations for funding pension schemes are typically less strict than they are for insurance companies.  One example is that pension schemes are allowed to run a deficit, i.e. hold fewer assets…

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Tags: Solvency II, longevity risk

Does Solvency II demand stochastic models?

(Jan 24, 2010)

Solvency II is a major overhaul of the reserving rules for insurers throughout the European Union.  An important consideration for annuity writers is how it will relate to longevity trend risk.  For example, consider the following text about "Statistical quality standards" as they refer to insurers' internal models:

"The methods used to calculate the probability distribution forecast shall be based on adequate, applicable and relevant actuarial and statistical techniques and shall be consistent with the methods used to calculate technical provisions. The methods used to calculate the probability distribution forecast shall be based upon current and credible information and realistic…

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Tags: longevity risk, Solvency II, ICA

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