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19 MARCH, 2009
LONGEVITY RISK SECURITISATION GOING FORWARD
Darryl Stewart - J.P. Morgan
C O N F I D E N T I A L
A N D
P R I V A T E
S T R I C T L Y
Introduction
Everyone has heard the background regarding the
increasing significance of longevity risk on insurers,
corporates and governments
What is less widely discussed is actual deal flow and the
F O R W A R D
things that need to continue for market growth
We have the benefit of the recent history of nat-cat ILS as
G O I N G
a road map
S E C U R I T I S A T I O N
But the differences in the risk class need to be recognised
and accommodated in developing the solutions
R I S K
L O N G E V I T Y
SIFMA 1
Longevity risk transactions in the traditional market
December 2004 / January January 2005 May 2005 June 24, 2005
2005 £650mm £2.2bn £1.5bn
£1.1bn 59,000 policies 52,000 policies
Seller: Royal London Seller: Royal London Seller: Resolution Seller: Resolution
F O R W A R D
Buyer: Prudential Buyer: Prudential Buyer: Canada Life Buyer: Prudential
May 2006 October 2006 March 2007 April 2007
£4.6bn £465mm £1.8bn £1.7bn
G O I N G
130,000 policies
S E C U R I T I S A T I O N
Seller: Equitable Life Seller: General Electric Seller: Equitable Life Seller: Friends Provident
Buyer: Canada Life Buyer: Swiss Re Buyer: Prudential Buyer: Swiss Re
April 2007 July 2007 February 2008 February 2009
£3.7bn £2.3bn £6.7bn £1.5bn
R I S K
Seller: Zurich Seller: Co-operative Seller: Standard Life Seller: Abbey Life
Buyer: Swiss Re Buyer: Swiss Re Buyer: Canada Life Buyer: Pacific Life Re
L O N G E V I T Y
SIFMA 2
Where will the risks come from?
UK is the Florida of longevity risk
The risk exists principally for the individual, contracts then
convert the exposure into a fungible form
F O R W A R D
Insurers providing personal pensions
Corporate sponsors of pension plans
Governments
G O I N G
Understand the legal and cultural drivers of the contract
S E C U R I T I S A T I O N
market
Everyone here understands hurricane patterns and contract
issue around nat-cat
R I S K
It's the job of the arrangers and the sponsors to provide the
same information for investors
L O N G E V I T Y
SIFMA 3
What structures will we see?
Derivatives versus securities
Parametric versus indemnity
Long durations versus really long durations
F O R W A R D
G O I N G
S E C U R I T I S A T I O N
R I S K
L O N G E V I T Y
SIFMA 4
Longevity risk transactions in the capital markets
February 2008 July 2008 March 2009
£500mm
F O R W A R D
G O I N G
S E C U R I T I S A T I O N
Lucida was concerned about Canada Life will pay to J.P. Details to be announced
improvements in mortality rates Morgan a series of fixed
for certain cohorts within their payments and will receive
portfolio floating payments
Lucida and J.P. Morgan J.P. Morgan concurrently
constructed a hedge to deliver entered equivalent swaps with
the offsetting longevity risk capital markets investors
R I S K
characteristics required
L O N G E V I T Y
SIFMA 5
Indemnity survival swaps
Indicative terms: Best estimate gross payments to investor
Investors enter into a long duration fixed- 400 Actual payments Fixed payments
to-floating longevity swap referencing the 300
200
benefit cashflows on a portfolio of 100
F O R W A R D
annuities in payment 0
(100)
(200)
The fixed leg of the swap is a series of (300)
defined payments payable from the insurer (400)
G O I N G
to the investor 2008 2012 2016 2020 2024 2028 2032 2036 2040 2044
The floating leg of the swap corresponds to
S E C U R I T I S A T I O N
Best estimate net payments to investor
the actual payments made to the portfolio
policyholders and is payable by the 18
16
investor to the insurer 14
12
The lighter fixed leg mortality generates 10
8
higher benefit payments on the fixed leg
R I S K
6
than are expected on the floating leg 4
resulting in an expected net payment to 2
L O N G E V I T Y
0
investors 2008 2012 2016 2020 2024 2028 2032 2036 2040 2044
SIFMA 6
Parametric mortality rate swaps
q-Forwards (mortality forwards) Term sheet for a single q-forward
Simple capital market instruments Notional GBP 50,000,000
amount
Effectively a zero-coupon mortality swap
Trade date December 31, 2006
Exchange realised mortality rate in a Effective date December 31, 2006
F O R W A R D
future period for a pre-agreed fixed Maturity date December 31, 2016
mortality rate Reference year 2015
Fixed rate 1.2000%
Fixed amount J.P. Morgan
G O I N G
payer
Net settlement at maturity
Fixed amount Notional amount × Fixed rate × 100
for fixed rate receiver
“Forward” rate Reference rate LifeMetrics graduated initial mortality
S E C U R I T I S A T I O N
rate for 65-year-old males in the
reference year for England & Wales
national population
Bloomberg ticker: LMQMEW65 Index <GO>
1.2000% Realised Floating XYZ Pension Scheme/Insurer
mortality amount payer
Floating Notional amount × Reference rate × 100
R I S K
amount
Settlement Net settlement = Fixed amount - Floating
L O N G E V I T Y
amount
SIFMA 7
Parametric survival swaps
Definition of a survival swap
Definition of a survival swap Deterministic annuity cashflow variation
Deterministic annuity cashflow variation
A survival swap is a cumulative rate 250 Variation in mortality improvement
derivative analogous to a zero coupon 200
interest rate or inflation swap 150
100
The floating rate payer will pay the product
F O R W A R D
50
of the notional amount and a compounded
0
(1-q) using the realised LifeMetrics Index
2007
2012
2017
2022
2027
2032
2037
2042
2047
2052
2057
2062
2067
mortality rate for an annually increasing age
G O I N G
The fixed rate payer will pay a
predetermined cash flow at the maturity
date
S E C U R I T I S A T I O N
Deconstructing an individual cashflow
Deconstructing an individual cashflow
Survival swaps of varying durations are
n
combined to create an exchange of synthetic Payment = Π (1 - qx+t ) × annual benefit
2006+t
t=0
annuities 200
150
Derivative Floating rate payment
Interest rate 100
R I S K
Notional × Π (1 + LIBORt)
swap 50
Inflation swap Notional × Π (1 + inflationt)
L O N G E V I T Y
0
Survival swap Notional × Π (1 – qx+t) 2012 2017 2022 2027
SIFMA 8
What will we need?
Credit intermediation
Modelling capabilities and standards
Imagination (eternal youth, black death)
F O R W A R D
G O I N G
S E C U R I T I S A T I O N
R I S K
L O N G E V I T Y
SIFMA 9
Is it coming together?
Economic capital models
Existential risks
Efficient agency structures
F O R W A R D
G O I N G
S E C U R I T I S A T I O N
R I S K
L O N G E V I T Y
SIFMA 10
