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Mortality Financial InstrumentsIAA Mortality Task Force
Marc TardifMay 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)
ILS Examples
Catastrophe bonds Parametric derivatives Catastrophe industry loss warranties
derivatives Catastrophe futures Mortality bonds Longevity swaps Life settlement swaps & indices
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)
Potential Problems for ILS
Acceptability of such forms of risk transfers by all stakeholders
Different legal, regulatory and accounting implications in different jurisdictions
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
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…
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
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
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)
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
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
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
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
Mortality Swaps (cont’d)
UK division of Canada Life– Placed through JPMorgan– Covers 500M pound book of British annuities
Thank you for your attention!