Bigger & Better? The US Life, Annuity & Pension Markets and Their Longevity Risk
The US Insurance life/annuity and pension markets continue to hold their position as the world’s largest in terms of assets. In 2017, life insurance and annuity invested assets and capital totalled $4.1 Trillion USD. Of the top 300 global pension funds, US funds represented 38% of total assets in 2018. During the same year, total US pension funds asset reached 105% of the country’s GDP. The US clearly dominates the global life/annuity and pension markets on the business side of things, but what types of retirement coverages are available to the American people?
Private or public?
Pension plans are the primary source of retirement funding in the US, though annuitisation is not compulsory, nor is it tax-incentivized for private individuals. Employers are not obligated to sponsor pension plans for their employees, though the government does provide sizable tax breaks for companies that decide to do so. In the private sector, approximately 60% of the American workforce has access to occupational pension plans.
The governmental Social Security program is also available for workers who retire after the age of 65, but the amount received depends on how much money is invested on a pay-as-you-go basis during the course of their lives. Social security tax is shared equally between employers and their employees, and is tax-exempt up to a certain amount.
In total, approximately 42% of the population enrolled in a pension scheme in the US have defined benefit (DB) plans, and 58% defined contribution (DC).
What about longevity risk?
Since the latest financial crisis which decimated insurers’ and pension providers’ portfolios, other financial risks such as investment and interest rate risks have taken the spotlight. But in recent years, as companies recover from the crisis, insurers, reinsurers and pension providers have woken up to the seriousness of their exposure to longevity risk.
The longevity risk US insurers, reinsurers and pension providers (and the US government in some cases) are exposed to are amplified for various reasons - for starters, the post-war baby-boomer generation has reached retirement age, meaning a large increase in payment obligations. With medical advancements and increased health awareness, baby boomers are living longer, increasing the longevity risk significantly.
Furthermore, up until recently, the Society of Actuaries in the US (SOA) published mortality forecasts every decade or so, which made it very difficult for insurers and pension providers to estimate the impact of longevity improvements on the risk they are exposed to. The lack of up-to-date mortality indices caused companies to underestimate liabilities by 5-8%, magnifying longevity risk exposure. The low-interest environment of the past few years has only increased the impact of longevity risk. Changes in regulation increasing requirements and regulatory complexity have stressed occupational pension plans to such a length that many pension providers have needed to freeze plans or offer lump sums in order to de-risk.
Many US public pensions have cost-of-living, inflation adjustments, and offer above-the-market discount rates, further increasing the risk the government is exposed to. Various politicians have even voiced concerns that the government will have to raise taxes in order to fund its payment obligations.
So what is being done about the risk?
As insurers, reinsurers and pension providers are waking up to the need to de-risk their portfolios, more de-risking solutions are being offered by reinsurers. A prudential executive mentioned that there is a “surge in demand” for reinsurance solutions in the last few years. American reinsurers have been able to maintain a stable revenue stream in the past decade, despite the market challenges they have faced. According to S&P, North America generated over half of the premiums in the life reinsurance market.
Unfortunately, as we mentioned in previous articles, traditional reinsurance simply doesn’t have the capacity to de-risk in the numbers needed by the US insurance and pension markets. While reinsurance transactions numbers and volumes are on the rise, they can only de-risk billions at a time, which leaves trillions-worth of risk unaccounted for.
Innovative solutions in Insurtech have started to tackle the reinsurance capacity problem, by turning to capital markets for de-risking. Capital markets have the capacity to provide the hedging and capital needed to de-risk portfolios of insurers, pension providers and reinsurance providers as well. Insurtech solutions can improve indemnity index calculations and risk modeling methods, minimizing basis and tail risks; they can provide the flexibility needed for a market with a very wide range of schemes and plans; and most importantly - the risk hedging and solvency relief insurers, reinsures and pension providers need.
Vesttoo, has developed advanced technologies for data-driven risk management, transferring actuarial risk to financial risk through the capital markets. Vesttoo specializes in risk modeling and alternative risk transfer for the Life and P&C insurance markets, providing insurers with a low-cost strategic risk management solution for immediate capital relief, value enhancement and liability hedging.