New Market for Longevity Risk

March 15, 2010

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853370_flaming_cakeAsset-liability matching is now a standard concept in the pension plan lexicon. But how easy is it to accomplish? In a complete market, there is a continuous auction among bidders and askers for all manner of assets. Such price discovery encourages further liquidity and brings more bidders and askers on board – increasing price discovery. But there is no real auction market for pension plan liabilities – neither DB nor DC.

If a plan succeeds, fine. There’s no hullabaloo from aggrieved shareholders or taxpayers, and barely a trickle of truculence from plan members. But if a plan doesn’t succeed … well then there’s a call for corporate flogging and government bailouts. But over what?

Pension plans have long-dated liabilities. It could be 20 years before a plan shows its weaknesses. Or it could be tomorrow. It depends on the balance between inflows from active members and outflows to retired members – give or take the performance of capital markets in propping up that virtuous circle.

But plan investments don’t always complete that virtuous circle. Still, it’s not just about investment performance. It’s about member longevity. This is new risk territory. And some European financial institutions have decided to make a market in swapping longevity risk.

The Life and Longevity Markets Association has recently set up shop in the U.K. to: ‘bring benefits to insurers and reinsurers by bringing structure to an embryonic marketplace, and capital markets investors through the growth of a new and uncorrelated asset class. Such a marketplace would permit new and flexible solutions to those with longevity and mortality exposures. It will also allow pension funds (and others with significant financial risk from longevity) to secure their members’ benefits for the long term, helping to develop much-needed stability in retirement systems.”

A new life for aging liabilities.

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