LONDON, Sept 24 Insurers do not have enough capacity to cover some $23 trillion in global pension liabilities against the risk that people will live longer than expected and should seek to pass such longevity risk through to investors, Swiss Re said on Monday.
In a report, the world's No.2 reinsurer said each additional year of life expectancy raises pension costs by about 4-5 percent, adding to the burden on pension funds and insurers.
Pension funds looking to minimise their exposure to an aging population have often used longevity swaps, through which a counterparty - often a reinsurer - takes on their liabilities for a defined period. If pension payments fall short of trustees' estimates, the counterparty pockets the difference, but must pay out if they overshoot.
But capacity within the reinsurance industry is running short and a capital markets-based solution needs to be found before reinsurers are unable to take on more longevity risk, Swiss Re said.
It suggested longevity risk should be packaged up and sold to investors in much the same way that insurers lay off risks from natural disasters such as hurricanes and earthquakes via the catastrophe bond market. Bonds issued by the government and with coupons linked to tax revenues could be another solution.
"A reliable and widely accepted benchmark index will be needed," Swiss Re said in the report.
Appetite for catastrophe bonds has increased, partly reflecting their perceived lack of correlation with other financial markets, and issuance this year could be the highest since the market began in the early 1990s, investors say. .
But longevity is tricky to price, with investors, pension funds and investment banks needing to agree on a forward projection of the cash flows related to either a population index or a specific pension block.
Capital markets investors have so far given a tepid response to the idea of a tradeable market in longevity risk, often disagreeing with pension funds' mortality assumptions.
Investors also tend to prefer shorter-term commitments than the 30-40 years a longevity transaction would require.
Swiss Re sold the first ever tradable rated security providing protection against longevity risk in December 2010. The $50 million eight-year catastrophe bond, sold via a special-purpose vehicle, Kortis Capital, passed on Swiss Re's longevity risk direct to capital markets investors.
The recently formed Life & Longevity Markets Association has published longevity indices, which could provide a reference for future transactions in England, Wales, Germany, the Netherlands and the United States.
But "it will take time before these indices are used widely", Swiss Re said.
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(Reporting by Sarah Mortimer; Editing by Catherine Evans)