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Aggregating Longevity Risk for the Capital MarketsA Necessary First Step
5th International Longevity Risk & Capital Markets Solutions ConferenceJP Morgan Chase Auditorium, 270 Park Avenue, New York25 September 2009
John H. FitzpatrickPartner and Director, Pension Corporation
Copyright © 2009 Pension Corporation LLP. All rights reserved. 2
Agenda
Current forces affecting the size and ownership of longevity risk
Why the risk is moving from the pension funds to professional pension insurers now
The result: a new and growing market for the professional pension insurers
Longevity risk: why it will move from pension insurers to investors
Longevity risk: pensioner characteristics favourable for investors
Likely issuers, why they will sell and what they will have to offer
Some constraints to address to increase volume of issuance
Summary and conclusions
Appendix
Copyright © 2009 Pension Corporation LLP. All rights reserved. 3
Current Forces Affecting the Size and Ownership of Longevity Risk
The Mosaic Today
Retirement population growing
Longevity risk moving from corporates to individuals
Cost of longevity significant and rising
Inflation could exacerbate longevity costs
Longevity extending
Credit Crunch moving longevity risk arguably to
Government
The UK population of retirees (i.e. people 65+) is set to increase by 60% by 2032 from 10 million to 16 million due mainly to the ageing of the baby boom generation
Longevity continues to increase for UK retirees at historically high rates against largely fixed retirement / entitlement dates
The current cost of life extension in the UK is estimated at £12.5 to £24.7 billion per year if GAD / ONS best estimate and high projections prove accurate
Current fiscal and monetary policy may be sowing the seeds of high inflation and expectations of inflation
Strong forces are causing corporates to close existing Defined Benefit (DB) schemes and transition to Defined Contribution / Personal Account schemes
The Credit Crunch is causing a significant increase in DB pensioner risk to move to the Pension Protection Fund (PPF)
Copyright © 2009 Pension Corporation LLP. All rights reserved. 4
The Four Forces:Why the Risk will Move from the Pension Funds to Pension Insurers
UK Pension Funds
Pensions Regulato
r –
Greater Powers
Pension Pro
tection
Fund
Investment Market
Volatility
Powers that have been granted, exercised and proposed continually raise bar for trustees, administrators and sponsors
Stock market performance has reopened deficits
Lower gilt yields Corporate bond spreads
Levy calculation on pension funds revised upwards and more risk-based
Recent proposal by ASB would raise liability value to ‘market value’
With market volatility, this becomes even more significant
Accounting – not just
FRS17 and IAS19
Copyright © 2009 Pension Corporation LLP. All rights reserved. 5
Pension Insurance Market: A Growing Market in the UK
0
20
40
60
80
100
120
140
160
180
2006 2007 2008 2009 2010 2011 2012
Year
GB
P b
n
Cumulative Projected Development of the UK Pensions Buyout and Longevity Insurance Market
Total of £1,000bn of private defined benefit pension liabilities in the UK
Rate of transfer to pension aggregators will continue to accelerate
– £3.5bn in 2007
– £8bn in 2008
– £11bn projected for 2009
Large schemes have turned to longevity hedging in 2009
20% to 25% of companies expect to enter into a buyout by 2012
25% of defined benefit plans to end accruals
Sources: (i) Lane, Clark & Peacock report, “Pension Buyouts 2008”; (ii) Watson Wyatt (March 2008) survey of 100 UK company pension sponsors; (iii) PwC Pensions Survey of 193 UK-based companies (October 2007); Pension Corporation estimates (iv) Snapshot survey of 100 companies by the National Association of Pension Funds (January 2009) (v) Pension Corporation
The Likely Path
Copyright © 2009 Pension Corporation LLP. All rights reserved. 6
Why Longevity Risk Needs to Move
Longevity: Unrewarded, historically underestimated and unmanaged, a material risk for pension funds
‘Natural or original’ owners of a risk are not the ‘best owners’
‘Best owners’ of longevity risk are the pension insurers and reinsurers / capital markets
– Spread risk around larger number of markets and participants
Risk flows to those best able to manage it
Pension Funds Capital Markets/ReinsurersPension Insurers
Original owners of longevity Underwrite price specific pension fund risk
Create large risk portfolios
Carry basis risk
Longevity not correlated to non-life, credit and market risks
Natural hedge (albeit not perfect) against mortality risk
Buy longevity indices on the population and specific portfolios
Copyright © 2009 Pension Corporation LLP. All rights reserved. 7
Longevity Risk is Starting to Move to Reinsurers / Capital Markets
Reinsurers
Have bought insured annuity risk
Now writing coverage for pension insurers
As improvement factors increase, reinsurer appetite increases
Capital Markets
Investment banks have recently arranged for longevity risk of insured annuities to be
distributed to investors, most recently in a reinsurer-led transaction for £0.5 billion
Investors buy $18 billion of Traded Life Policies / Life Settlements per year (longevity risk on
wealthy Americans)
Populations indexes have been created on which derivatives will develop
Capacity is growing but at a slow pace
Copyright © 2009 Pension Corporation LLP. All rights reserved. 8
Moving Longevity Risk:Recent Transactions (Europe)
Date Risk OwnerSize (GBP millions)
Type of Longevity Risk
Risk Recipient
January 2008 Lucida Not disclosed Life annuitantsCapital markets
investors
July 2008 Canada Life £500 Life annuitantsCapital markets
investors
February 2009 Abbey Life £1,500 Life annuitants Reinsurers
March 2009 Aviva £475 Life annuitantsReinsurers and capital markets
investors
June 2009Babcock
International£500 – £750 Pensioners Reinsurers
July 2009 RSA £1,900 PensionersPension insurer and reinsurers
September 2009 (announcement)
Royal County of Berkshire
[£500 – £750] Pensioners [Pension insurer]
Total (Jan 08 – Sep 09)
£5,375 – £5,875
Copyright © 2009 Pension Corporation LLP. All rights reserved. 9
Longevity Risk:Favourable Characteristics for Investors
No known correlation of longevity risk to credit, market, interest rate, or inflation risk
A new asset class providing diversification to ILS and other fixed income portfolios
Not “binary” as in hurricane, earthquake or extreme mortality securities
Could be used as a hedge to life insurance risk (risk of early death) securities
Long-dated securities
Copyright © 2009 Pension Corporation LLP. All rights reserved. 10
Longevity Risk of PensionersQualitative Advantages for Investors
Anti-Selection risk
– None: pensioners are members of pension fund based on prior association as employees
Access to historical mortality experience data for pension funds
– Allows for analysis of past experience and enables more accurate mortality projections
Pension portfolios possess homogeneous populations
– Low average pension amounts (<$5,000 payment p.a. per life)
– Geographical and socio-economic diversity
– Life expectancy of a large pool of pensioners will be more closely linked to the overall population
Number of lives in a portfolio
– Pension book of $500m may cover as many as 10,000 pensioners
– Volatility reduces for larger populations (“Law of Large Numbers”)
Copyright © 2009 Pension Corporation LLP. All rights reserved. 11
Investment in Longevity of Pensioners Through a Swap
Expected Pension Payments + Fee
Time
TimeHeavier Mortality
Actual Pension Payments
Swap defines an expected “cash flow line” based on agreed mortality basis and assumptions for future improvements
Investor pays to Pension Insurance Corporation the Actual Pension Payments due to the pensioners in return for the Expected Pension Payments plus a Fee
Expected Pension Payments(“Fixed Leg”) + Fee
Actual Pension Payments(“Variable Leg”)
Pension Insurer
Investor
Transaction Mechanics
Key Features
High return (8%-10%)
Low volatility (due to “Law of Large Numbers”)
Initial collateral payment by investor
Mark-to-Model payments, if required, by investor (on extension of longevity)
Payment of fees plus remainder of Expected Pension Payments plus return of collateral to investor (on death of covered lives)
Copyright © 2009 Pension Corporation LLP. All rights reserved. 12
Longevity Risk of PensionersLikely Issuers, What They Can Sell and Timing
Professional pension insurers
– Large portfolios of pensioners, well diversified pools
– In a standardised Index form (i.e. pension insurers can retain basis risk) or reflecting large actual pension portfolios
Insurers with annuity blocks
– Has anti-selection risk, but this can be priced
Large corporates with sophisticated risk management functions and large enough pension funds
– Unlikely to transact directly with the capital markets on longevity risk in large volumes
Timing: Given the current size and growth of the professional pension insurance market, risk is available now
Copyright © 2009 Pension Corporation LLP. All rights reserved. 13
Longevity Risk Transfer:Current Constraints with Capital Markets
Risk Owner
Pension Insurers
Full longevity risk transfer
Partial risk transfer
Reasons for capital markets constraints
Potential Solutions
Limited quality and quantity of information
Granular data
Capital markets reporting standards
Use of specific sizeable portfolios
Redemption rights
Desire to trade out
Medium term solution: long-term investment i.e. no-redemption structures
Long term solution: liquid longevity market
Pension Insurers
Capital Markets
Indemnity basis risk
Index-based cover
Duration basis risk
Limited duration
cover
Copyright © 2009 Pension Corporation LLP. All rights reserved. 14
Summary & Conclusion
Longevity Risk is growing fast, due to demographics, lifespan extension, and developing long-term inflation trends
Pension Funds have been significantly increasing their assumptions for longevity, enabling pension portfolios to become insured
Longevity Risk is moving to Pension Insurers and other aggregators, a necessary first step for distribution to Capital Markets
Aggregators of longevity risk bridge the gap between the needs of the pension funds and the requirements of the capital markets investors
Analysis of longevity data, historical and current, has substantially improved in recent years, aiding all market participants, with forward-looking medical-based models being developed
Investors should employ methodologies to analyse longevity risk: geographic, socio-economic factors
Volatility should be very low for large portfolios of homogenous pensioner longevity risk, even though longer duration than many ILS products
Appendix
Copyright © 2009 Pension Corporation LLP. All rights reserved. 16
The UK Population of Retirees is Increasing
The share of people aged 65 years and over or 85 years and over in total population has and will continue to increase substantially
The combination of increases in life expectancy and the fact that more people reach old age is expected to have a profound impact on society
The UK population of retirees (i.e. people 65+) is set to increase by 60% by 2032 from 10 million to 16 million due mainly to the ageing of the baby boom generation
Chart 5: Number of people aged 65+ and 85+ (millions)
0
2
4
6
8
10
12
14
16
18
20
1982 1992 2002 2012 2022 2032 2042
Source: GAD, 2006-based principal population projections and ONS population statistics.
65+ 85+
Copyright © 2009 Pension Corporation LLP. All rights reserved. 17
Increasing Longevity is Here to Stay
Longevity continues to increase for UK retirees at historically high rates against largely fixed retirement / entitlement dates
Source: GAD, 2006-based principal population projections and ONS population statistics
Period expectation of life at age 65, E&W
5
10
15
20
25
1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Year
Exp
ecta
tion
of li
fe (
year
s)
Males
Females
Copyright © 2009 Pension Corporation LLP. All rights reserved. 18
The Cost of Longevity Extension to Corporates / DB Schemes, Governments and Individuals
Membership(1) Liability(1) Cost (p.a.) if LE extends (2)
(no. of people)
by ½ year every 5 yrs
by 1 year every 5 yrs
Corporate sponsors of Defined Benefit schemes 15m £850bn £3.0bn £6.0bn
Government
- Public sector schemes
- State benefits
20m
45m
£1,100bn
£1,400bn
£3.9bn
£4.9bn
£7.7bn
£9.8bn
Insurance Companies
- As issuers of annuities
- As pension insurers
6m
< 0.3m
£160bn
£12bn
£0.6bn
£0.1bn
£1.1bn
£0.1bn
Total £3,519bn £12.5bn £24.7bn
UK GDP £1,400bn 0.9% 1.8%
1. Source: The Purple Book 2008; PIC estimates. 2. PIC assumption: liability increases by 3.5% for every year of longevity extension.
Current cost of life extension is estimated at £12.5 to £24.7 billion per year if GAD / ONS best estimate and high projections prove accurate
Copyright © 2009 Pension Corporation LLP. All rights reserved. 19
Realities are Forcing Longevity Risk to Move from Corporates to Pension Insurers, Individuals and Governments
Current fiscal and monetary policy may be sowing the seeds of high inflation and expectations of
inflation. Most pension benefits are indexed to inflation (although portions are limited to 0% - 5%
p.a.) which may increase cost of life extension
Strong forces are causing corporates to close existing Defined Benefit (DB) schemes and
transition to Defined Contribution / Personal Account schemes, causing longevity risk to shift from
corporates back to individuals
The Credit Crunch is causing a significant increase in DB pensioner risk to move to the Pension
Protection Fund (PPF). While it can be argued that the longevity risk stays in the solvent DB world
through the levy, the PPF becomes a large bearer of longevity and other risks, which may not be
sustainable
Copyright © 2009 Pension Corporation LLP. All rights reserved. 20
How Can Policy Actions Adapt to Increased Longevity to Create the Pension System of Tomorrow?
Government
As with state pensions, gradually move retirement age to correspond to increasing longevity
for all public sector schemes
HM Treasury should consider issuing long-dated longevity linked gilts
Work rules regarding mandatory retirement / flexible work incentives need to be looked at
Fiscal expenditure needs to be controlled to create room for future pension expenditures
ONS - Continue to improve the quality of data relative to longevity
The Pension Regulator – promote the improvement of data quality, sound funding practices
Can lead the discussion and creation of the pension system of tomorrow
Copyright © 2009 Pension Corporation LLP. All rights reserved. 21
How Can Policy Actions Adapt to Increased Longevity to Create the Pension System of Tomorrow? (Cont’d)
Individuals
Increase savings rates into DC / Personal Accounts to accommodate higher longevity
Prepare to work part-time in later life
The question of whether they are the best holders of longevity risk needs to be re-examined
Businesses
Businesses increasingly close DB schemes but should they consider hybrid DB / DC schemes?
Continue to transfer legacy liabilities to pension insurers
Examine ways of hedging future liability growth, e.g. longevity insurance
Index future retirement accrual to longevity
Insurers / Capital Markets
Providers
Continue to innovate the transfer of longevity risk to the capital markets
Work with modelling firms to develop a forward-looking, medical-based longevity model
Key to the conversion of asset pools to secure retirement income streams for the population
Must develop a method to efficiently re-pool the longevity risk from individuals to insurers / capital markets
Copyright © 2009 Pension Corporation LLP. All rights reserved. 22
Pension Corporation is a focused financial services organisation that has been established to provide innovative and affordable solutions to pension funds and their sponsors
Pension Corporation offers both full insurance and other pension risk transfer products
Pension Corporation has a large and strong investor base including the Royal Bank of Scotland, JC Flowers, Swiss Re, Sampo Life, Istithmar World and a number of other institutional investors
JP Morgan became an investor during November 2008
Pension Corporation provides increased levels of security and stability for scheme members through Pension Insurance Corporation, a fully authorised and FSA-regulated insurance company
Pension Corporation has £5.3bn of pension fund liabilities, £3.1bn as sponsoring employer and £2.2bn as insurer
Pension Corporation has the largest equity capital of any provider in the sector – close to £1bn
Pension Corporation InvestmentsCorporate Solutions Pension Security Investment Corporation
Guernsey-regulated (Re-) Insurer
Pension Insurance CorporationFSA-regulated Insurer
Insurance SolutionsCorporate Solutions
Pension Corporation:Overview
Copyright © 2009 Pension Corporation LLP. All rights reserved. 23
Pension Corporation Management and Board:Unrivalled Expertise in the Pension Insurance Arena
John CoomberChief Executive Officer
Director and former Chief Executive Officer of Swiss Re; Fellow of the Institute of Actuaries
Sir Mark WeinbergChairman
President of St James's Place plc, co-founder in 1991 of St James's Place Wealth Management Group;
Co-Founder of Hambro Life (Allied Dunbar) in 1969
Edmund TruellDirector
Founder of Duke Street Capital; 22 years experience in building up private equity business; built largest leveraged loan investor in
Europe from start-up to sale
Executive Officers Directors
Edward GieraHead of Global Pensions Advisory Business at
JP Morgan. Previously head of Debt Capital Markets Leveraged Finance
and Structured Finance
Bob ScottFormer Group CEO of Aviva plc and former
Chairman of the Association of British Insurers; Director at Jardine Lloyd Thompson
and Swiss Re
Ravi SinhaHead of Europe and Managing Director of
J C Flowers & Co LLC; former Managing Director Goldman Sachs
John AmatoChief Investment Officer, Istithmar;
formerly at Lehman Brothers
John LovelessFormer Head of Trust and Private Banking,
SG Hambros
John H. FitzpatrickFormer CFO of Swiss Re; former CEO of
Swiss Re Life & Health; 28 years of insurance and financial management
Sir Nicholas MontaguFormer Chairman of HM Inland Revenue
Kari StadighGroup Deputy CEO Sampo plc. Chairman of P&C Insurance Holding Ltd and Sampo Life
Insurance and the Federation of Finnish Insurance Companies
Nick ParkerFormer Managing Partner at
PricewaterhouseCoopers for Project Finance and Privatisations
Danny TruellChief Investment Officer, Wellcome Trust;
former co-head of Global Investment Strategiesat Goldman Sachs Asset Management
Graham CooperFellow of the Institute of Actuaries; founded New
Bridge Street Consultants pension and actuarial practice in 1986
Philip MooreGroup Finance Partner
Former Group Chief Executive and Group Finance Director of Friends Provident plc (2003 – 2007); was Director of
F&C Asset Management plc and Board Member of the Association of British Insurers. Previously Partner at PricewaterhouseCoopers
leading insurance consulting practice in South-East Asia
Rob SewellChief Financial Officer
Former UK Finance Director for Legal & General. Former CEO and CFO for National Westminster life assurance.
17 years financial service experience
Sir Martin JacombFormer Chairman of Prudential plc;
former Deputy Chairman of Barclays Bank and Director of the Bank of England
Copyright © 2009 Pension Corporation LLP. All rights reserved. 24
Disclaimer
This information is issued by Pension Corporation LLP (“Pension Corporation”), a limited liability partnership registered in England (registration number OC316968) with its registered office at 14 Cornhill, London EC3V 3ND. This document is confidential and proprietary to us and is being provided solely for your use and is not intended for any further dissemination. In particular (and without prejudice to the generality of the foregoing), this document may not be reproduced, distributed, passed on, or the contents otherwise divulged, directly or indirectly into any country, territory or possession where to do so may contravene local law or regulation. This document remains our property and, on request, must be returned to us. In addition, on request any copies made must be destroyed and written confirmation provided to us that this has occurred. Nothing in this document should be construed as legal, tax or investment advice. Unless otherwise agreed in writing, Pension Corporation and its affiliates are not acting as your financial adviser or fiduciary. This document is for information purposes only and does not constitute an invitation or inducement or an offer or commitment, a solicitation of an offer or commitment, or any advice or recommendation, to conclude any transaction.
While information herein has been obtained from sources believed to be reliable, no liability is accepted if this is not the case. Accordingly, we do not represent it to be accurate or complete. The information contained herein includes illustrations, estimates and projections and involves significant elements of subjective judgment, assumptions and analysis. Any views or opinions (including illustrations, estimates, statements or forecasts) constitute our judgment as of the date indicated and are subject to change without notice. No representation is made as to the accuracy of such illustrations, estimates or projections or that all assumptions relating to them have been considered or stated or that such projections or returns will be realised. The returns or performance results may be lower than estimated herein. The information contained herein does not purport to contain all of the information that may be required to evaluate such solutions and you are encouraged to conduct independent analysis of the data referred to herein. We do not undertake to update this document.
Before you enter into any transaction, you should ensure that you fully understand the potential risks and rewards of that transaction and you should consult with such advisers as you deem necessary to assist you in making these determinations. No reliance should be placed on any representation or undertaking inconsistent with the above paragraphs. Notwithstanding the confidential nature of this document and its contents, if required by any applicable law or regulation we may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction(s) contemplated herein and all materials of any kind that are provided to you relating to such tax treatment and tax structure. This document is not intended to be and must not alone be taken as the basis for a decision to enter into any transaction which may be described herein.
By accepting delivery of this document, the recipient agrees not to reproduce or distribute this document in whole or in part and not to disclose any of its contents (other than to obtain advice on it from a legal, business, investment or tax advisor) without the prior written consent of Pension Corporation.
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Recipients of this document should not treat its contents as advice relating to legal, taxation or investment matters and are advised to consult their own professional advisers concerning any transaction that may be described herein.