The mighty and massive global derivatives market continues to grow in new and intriguing directions. According to consultancy Hymans Robertson the market for derivates dedicated to “longevity risk” (the risk that a pension fund will not be able to fund its pension promise as lifespans increase) is exploding.
Of no surprise to anyone in the investment industry: It is becoming more difficult to fund retirements. People are living long than ever. At the same time low interest rates are making it harder to generate the necessary cash flows. As so-called “longevity risk” increases, big pension funds have taken to hedging this risk through longevity derivatives.
These derivatives have been more common in Europe. But now they seem to be taking off in North America. According to the stats, the longevity hedging market in Q1 2014 realized the highest level of activity on record. According to the report, a massive £4.4 billion of pension transactions were completed during the quarter. A single £5 billion longevity swap involving insurer Aviva helped make the quarter a record.
As it is, pension funds run the risk that present value of their annuity payments will turn out higher than expected. As lifespans increase the payments to those who have bought life annuities will as well. There is today a fascinating debate going on about how long lifespans can continue to increase. The conservatives argue there is a natural limit to lifespans. Others argue insurance companies will be surprised to see lifespans continue to expand, putting great pressure on the ability of firms to continue annuity payments.
As plan administrators in Canada consider the use of longevity risk hedging contracts OSFI has announced it intends to monitor developments. Last week the Ontario Superintendent of Financial Institutions published a policy advisory providing information and guidance to administrators of federally regulated defined benefit pension plans that are considering entering into a longevity insurance or longevity swap contract.