A consultative report published by the forum – Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks – notes that the “ageing population phenomenon” in many countries means retirement schemes face paying out on pensions and annuities for longer than anticipated.
The report cites an International Monetary Fund estimate that each additional year of life expectancy adds 3%-4% to the present value of liabilities of a typical defined benefit pension fund. As a result, schemes are increasingly seeking to transfer their longevity risk, through buy-outs, buy-ins and longevity swaps.
While most LRT activity has so far occurred in the UK, the potential size of the global market is significant – given that total annuity- and pension-related longevity risk exposure is estimated at $15trn-$25trn (€11trn-€19trn).
Indeed, last year witnessed several large non-UK transactions, including $26bn and $7bn pension buy-outs for General Motors and Verizon Communications respectively, and a €12bn longevity swap between Aegon and Deutsche Bank.
The threat to banks
Although the report notes that “LRT markets are not sizeable enough to present immediate systemic concerns”, it warns of similarities with credit risk transfer markets in the run-up to the recent banking crisis – where “a proliferation of complex products resulted in the buildup of concentrated leveraged positions.”
Investment banks – which tend to act as intermediaries in LRT deals, rather than holders – could become exposed to any crystallised longevity risk, in the event that their counterparties are unable to meet contractual demands.
“When the market has had time to grow to sizeable proportions before a stress scenario occurs, longer life expectancy may have repercussions on the broader financial system, particularly given that (investment) banks are involved,” the report adds.
To mitigate such threats, the Joint Forum makes eight recommendations, including greater international communication between regulators, closer monitoring of LRT markets, and further work on banking sector exposure.
A copy of the consultation can be downloaded from the Bank for International Settlements website, here. Comments on the report should be submitted by email before 18 Oct 2013, to baselcommittee@bis.org.
