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Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

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Page 1: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Mortality Financial InstrumentsIAA Mortality Task Force

Marc TardifMay 30 2009

Page 2: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Capital Market’s Appetite for Insurance Risks

Traditionally invested in risk bearing companies through equity or corporate debt

Interest in investing in individual risks via Insurance Linked Securities (ILS)

Source of diversification (thought to be uncorrelated to broader financial markets)

Page 3: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

ILS Examples

Catastrophe bonds Parametric derivatives Catastrophe industry loss warranties

derivatives Catastrophe futures Mortality bonds Longevity swaps Life settlement swaps & indices

Page 4: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Characteristics of ILS

Index based (generally) Collaterization minimizes credit risk Reduced capital credit due to basis risk Fixed contracts for multiple years Up-front fees for banks, modelers, legal

advice Transaction level services Alternative source of capacity (for cedants)

Page 5: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Potential Problems for ILS

Acceptability of such forms of risk transfers by all stakeholders

Different legal, regulatory and accounting implications in different jurisdictions

Page 6: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Bond Structure

Sponsor enters into reinsurance contract with Single Purpose Reinsurer (SPR)

Sponsor may use a captive or fronting company

SPR issues bonds to investors Reinsurance recoveries by Sponsor results in

principal reductions under the bond

Page 7: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Longevity Derivatives

Protects against risk of increased life span on a book of annuities

Potential secondary benefit is reduced requirement for risk capital in some regulatory regimes

Market in early stages of development Possible buyers: insurers and pension funds Possible providers: states with large older

populations, pharmaceuticals…

Page 8: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Evolution of Life Securitization

Mortality Risks (Cat Bonds) Slow beginning in mid-’90s Recent examples:

– VITA from Swiss Re (2003, 2005 and 2007)– OSIRIS from AXA (2006)– TARTAN from Scottish Re (2006)– SCOR with JPMorgan (2008)

Lagging behind banks (2006)– Europe only: 450Bn Euros in ABS/CDO– Worldwide: $30Bn in ILS

Page 9: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Evolution of Life Securitization (cont’d)

Longevity Risks Gaining interest since late 2006 Driven by US and UK concerns Potential large exposure ($20 Trillion) Life indices created (Credit Suisse,

JPMorgan) Such indices needed to develop basic

derivatives No natural “assumers” of longevity risks

Page 10: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Evolution of Life Securitization (cont’d)

Longevity Risks (cont’d) Capital market solutions

– Cash flow hedging through survivor swaps/forwards

– Capital hedging through short-dated reverse mortgage bonds or long-dated convertible securities (contingent on drift of mortality improvements)

Page 11: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Examples of Life Indices

JPMorgan’s LifeMetrics– Updated annually– Uses graduated initial rates of mortality (qx) for

ages 20-90– Population data from England&Wales, Germany,

Netherlands or USA

Credit Suisse’s Index– Similar to LifeMetrics– Based on USA mortality only

Page 12: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Examples of Lie Indices (cont’d)

Goldman Sachs’ QxX– Data from 46,290 insured lives (not

general population)– All aged 65 or more– Published monthly on the 2nd Thursday of

each month– One index addresses mortality, another,

longevity

Page 13: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Mortality Swaps

Similar to interest swaps One party pays “expected payouts” and

receives from 2nd party “actual payouts” Often need longevity index such as

JPMorgan’s LifeMetrics

Page 14: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Mortality Swaps (cont’d)

Examples Norwich Union (AVIVA)

– Uses RBS as trust– Covers 450M pound book of British annuities– Investors receive expected monthly payments

and pay back actual payment to NU– Covers cash flows for 10 years; residual will be

commuted– Partner Re is one of the investors providing

credibility in pricing to non-insurance investors

Page 15: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Mortality Swaps (cont’d)

UK division of Canada Life– Placed through JPMorgan– Covers 500M pound book of British annuities

Page 16: Mortality Financial Instruments - IAA Mortality Task Force · Mortality Financial Instruments IAA Mortality Task Force Marc Tardif May 30 2009

Thank you for your attention!