Managing Longevity Risks.

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Longevity risk from the perspective of an insurance company or defined benefit plan
sponsor is the exposure that a company has to unexpected decreases in mortality. This
is the opposite of mortality risk, which is exposure to increases in mortality. Longevity
risk has developed as experience emerges about the consistent increase in life
expectancy, combined with the long term nature of many guarantees that insurance
companies have written.
Many countries including Kenya are experiencing an increase of life expectancy due improved
health facilities, proper education, diversification in agricultural produce and increase in living
standards. There is evidence of slight increase of life expectancy by five to six years.
Financial differences concerning longevity and mortality risks
Longevity appears as a trend risk whereas mortality is a variability risk. Is there orthogonality
between mortality and longevity? In other words, can we “buy” mortality risk in order to hedge
longevity risk? How could we price a trend risk? Long-term horizons have financial
consequences: interest rate risk often becomes predominant. Oscillations around the average
trend are also important because their size cannot be neglected and also because they can lead to
over-reactions by insurance managers, regulators, policyholders and governments. Even if a
certain mutualization between mortality and longevity risks obviously exists, it is very difficult
to obtain a significant risk reduction between the two, because of their different natures. Indeed,
the replication of life annuities with death insurance contracts is not perfect because it does not
concern the same group of people and mortality portfolios give a huge importance for the insured
individuals who have a big share of the portfolio capital. Thus, the hedge is often bad because of
the variability related to the death of the insured individuals whose death benefits will be high.
Possible solutions to manage longevity risks;
Product design
A standard life annuity typically removes both longevity and investment risks from an
individual, making it very expensive for consumers. A more flexible sharing of risk between
consumers and insurers will allow for products that are more marketable to the public while
remaining viable for insurers. Some existing examples are listed below:
• Variable annuities -Payments are adjusted with the investment performance of the underlying
assets. Investment risk is thus shared between insurer and consumers.
• Participating annuities – Consumers share in certain investment and mortality gains of the
• Impaired life annuities – These are for consumers whose health condition is worse than
average. They are priced lower than a standard life annuity.
• Reverse mortgages – Consumers are allowed to borrow against the value of their home,
releasing the wealth tied up in the property.
A variety of features can be added to make these products more appealing to potential customers,
while easing risk management for insurers. However, it appears that wider adoption of these
innovations requires development of a robust “life market” and provision of suitable government
Developing the market
The life market is a market where (standardised or over the-counter) mortality and longevitylinked
securities or liabilities are traded. This allows insurers and reinsurers to spread their risks
among each other and with investors who want to diversify their portfolios with assets that are
uncorrelated with traditional financial markets. There are a number of recent developments in
this area in the UK and Europe. For example, new life companies have been set up to buy out the
Defined Benefit (DB) pension liabilities of employers in the UK. Some reinsurers and
investment banks have constructed survivor bonds, survivor swaps, and survivor indices. In
particular, the Life and Longevity Markets Association (LLMA) was established in 2010 by a
large number of insurers and investment banks to promote the development of a liquid “life
Government initiatives
Governments can also play an important role in overcoming the various demand and supply
constraints faced by the longevity risk market. Firstly, a country’s retirement system has a
significant impact on the development of the longevity insurance market. For example, countries
with some form of mandatory annuitisation, like the UK, have more developed annuity markets.
Secondly, there is much scope to increase promotion and education on managing longevity risk
to the general public. Thirdly, the government can provide guarantees and sponsorships to
encourage insurers to offer products that it deems important for the country. For example, the US
reverse mortgage market was stimulated by a government-sponsored mortgage insurance
programme. Governments may also increase issuance of long-term bonds, that could help
insurers hedge interest rate risks. Apart from the above, governments can also promote greater
active academic and industry research, with a more comprehensive collection and study of
insured and annuitant mortality experience. These would greatly enhance industry knowledge of
longevity risk and enable industry practitioners to design, price, and hedge longevity products
with more confidence. In addition, more data on expenditures of the elderly can be collected, and
perhaps a separate consumer price index can be constructed with these data. Such information
would be useful for consumer education and product development. In conclusion, the
management of longevity risk is still in its infancy, and more active discussion, research, and
participation is needed from both industry practitioners and academics. With the right mindset
and patience, there is a good chance that decent solutions to this pressing and unavoidable
challenge will be found in due course.

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