An Outcome of Longer Lifespans: Death Derivatives

Banks are now forming death derivatives to help pension funds better manage longevity issues.

(May 17, 2011) -- Goldman Sachs, Deutsche Bank, and JPMorgan Chase & Co. want to help investors bet on people's deaths, Bloomberg is reporting.

According to the news service, pensions are purchasing insurance against the risk of their members living for longer than anticipated. Yet, it has become increasingly difficult to find buyers willing to take that risk, packaged in the form of bonds and other securities. JPMorgan and Prudential have set up a trade group to establish a secondary market for longevity risk, while Goldman Sachs and Deutsche Bank have created insurance companies that promise to pay pensions if retirees live beyond a certain age, Bloomberg reported.

Schemes are increasingly transferring risk to insurance companies, driven by merger and acquisition activity, a growing number of closures and part-closures of defined benefit pension schemes, and concerns over longevity risk. A March report by Hymans Robertson has shown that UK pension buyouts, in which an entire scheme is passed to a specialist insurer, are becoming more and more prevalent.

“An increase in mergers and acquisitions activity is driving this,” James Mullins, head of buy-out solutions at Hymans Robertson, told the Financial Times. “Any potential purchaser will welcome a company that has already done a deal to transfer risk to an insurer. There is less to worry about,” he said, noting that concerns over longevity risk coupled with a greater number of closures and part-closures of defined benefit pension schemes have fueled the trend.

A recent example illustrating the growing popularity of risk transfer deals is the Pension Insurance Corporation's (PIC) decision in February to reinsure $799 million of longevity risk to better manage risk and more effectively compete for new business.

Similarly, in January, Swiss Re, the giant European-based reinsurer, decided to transfer $50 million in longevity risk. The investors in the Swiss Re deal were largely pension funds and other insurers.