AMSTERDAM Pension funds have just begun to use derivatives to hedge or even invest in longevity risk, according to speakers at the Fourth International Longevity Risk and Capital Markets Solutions Conference, held Sept. 25-26 in Amsterdam.
Really, this new market has emerged, said Guy Coughlan, London-based managing director in JPMorgan Chase Bank NA's pension advisory group, speaking at the conference. Deals have been done involving both longevity risk and mortality risk.
Although markets are just starting to emerge, experts believe that within a few years institutional investors will be able to sell longevity risk to the market and invest in that risk by using vehicles similar to life-settlement bonds. Those bonds, in which some Dutch pension funds have already begun investing, are backed by life insurance policies and have been dubbed death bonds because the investor cashes when people die.
Longevity risk is hard to pinpoint because life expectancy is based only on current observations, not projections. But if life expectancies continue to grow someone will have to foot the bill, said Joanna Kellermann, executive director of De Nederlandsche Bank, Amsterdam, the Dutch central bank, where pension supervision is part of her responsibilities.
Pension funds can hedge longevity risks by using derivatives.
The vast majority of pension funds are looking at (new capital market offerings) as hedges. Some defined benefit pension funds very small in number are looking at these as potential investments, Mr. Coughlan said in an interview after the conference.
In July, JPMorgan developed a £500 million ($890 million) customized longevity swap for an unidentified U.K. insurance company that was hedging its risk; JPMorgan then sold its risk to investors.
Although the customized hedges will play an increasing role in longevity hedges in years to come, standardized index derivatives will be preferred by investors in the short term because they are cheaper, more liquid and have shorter maturities than customized hedges, Mr. Coughlan said.
There is some question about the importance of longevity risk to U.S. pension funds. Longevity risk ranked at the bottom of concerns among corporate and public pension plan in North America who were surveyed in June 2007 by State Street Corp., Boston (Surge in retirement assets can't mask huge liabilities, lack of savings, PIonline, April 25). Liability mismatch topped the list, with 47% of respondents naming it as the greatest risk they faced in managing their plan, followed by 42% who said investment risk; 6%, operational risk; and 5%, longevity risk.
However, at the conference, Ms. Kellermann said longevity risk exceeds commodity risk and is almost as important as currency risk to pension funds.
Speakers said that larger pension funds, especially well-funded ones that have already hedged interest rate and inflation risks, will likely be the first to put longevity hedges in place.
But Ronald Wuijster, director of strategy and research at the €240 billion ($338 billion) All Pensions Group Investments, an independent pension administrator in Amsterdam, Amsterdam, said hedging longevity exposure is very expensive, that the market is undeveloped and that transparent and unbiased benchmarks are lacking.
Instead, Mr. Wuijster said pension funds ought to look at insurance-linked securities for investment opportunities for their low correlations with other asset classes and interesting returns.
Gilles Dellaert called longevity a developing asset class and pegged possible returns at 200 to 700 basis points above the London interbank offered rate. Mr. Dellaert is a vice president at Goldman Sachs, New York.
Executive Editor Joel Chernoff contributed to this article.