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Institutional Investors - Longevity-Linked Assets Are the Investment Your Portfolio Needs

Ever since their commence in the mid 2000s, longevity-linked assets have increasingly provided investors with non-correlated, high-yield investments and an attractive diversification option for their portfolios

April 15, 2020
Institutional Investors, longevity-linked assets
Institutional Investors can benefit from Longevity-Linked-Assets in their portfolio

Life expectancy has been increasing worldwide for decades. Unfortunately, life expectancy projections in the past have underestimated the increase, causing life insurers and pension funds to be exposed to much greater risk and liabilities than expected. While insurers and pension funds were aware of this issue before the 2000s, high returns helped soften the blow and not much was done in order to limit their exposure to longevity risk.

In the early 2000s, lower interest rates and poor equity market performance, followed by increasing governmental regulation on life and pension products, stressed insurer/pension fund balance sheets and solvency ratios to the limit. This pushed them into action, causing them to search for new ways to manage their longevity risk exposure through the capital markets using longevity-linked assets (LLA), a type of Insurance-linked security (ILS). This created the Longevity Risk Market - an exciting emerging market for investors.

Since it’s early years, the Longevity Risk Market has seen stable growth, with demand for longevity-linked assets only rising. The Longevity Risk Market is currently evaluated at approximately $60-80 trillion USD worldwide, and has been breaking activity records year after year, creating unique and profitable investment opportunities.

cumulative pension risk transfer
Source: Still living with mortality: the longevity risk transfer market after one decade by D. Blake, A. J. G. Cairns, K. Dowd and A. R. Kessler

Why are longevity-linked assets so attractive for investors?

Longevity-linked assets provide many benefits for investors. They are high-yielding fixed-income assets which are largely uncorrelated to macroeconomic risks, other financial asset classes or other mortality-linked security classes, providing solid portfolio diversification opportunities. Portfolio-specific indemnity Index-based LLA typically have long time-to-maturity, increasing market liquidity and allowing competitive pricing - benefiting portfolio returns. Investors have embraced LLA investment opportunities, leading to steady market growth since 2007.

Diversification is key

Investor appetite for diversification is strong, as many still remember the painful lesson learned from lack of diversity during the financial crisis of 2008. With the Covid-19 pandemic currently raging around the world, and talk of the financial crisis of the century coming, diversification is more important now than ever.

LLA provide a variety of non-correlated securities to invest in, with different deal structures, strategies and types of risk for diversification. In a Willis Towers Watson survey questioning investors about the motives for investing, for example, 96% of the investors stated non-correlation to traditional markets as the main reason for investing and 64% stated diversification of their portfolio as the main main reason for investing. 20% mentioned attractive pricing to be one of their motives, and 12% the potential for high returns.

Motives for investing in ILS assets
Source: Willis Towers Watson

Uncorrelated to macroeconomic risk and other financial classes:

LLA have been very resilient to global crises and even years with less-than-expected growth have shown low historical correlation with the traditional markets and low volatility. During the global financial crisis that began in 2008, for example, global equities were down over 50%, but the Longevity Risk Market continued to show growth. With insurers and pension providers rushing to de-risk their portfolios in light of the Covid-19 crisis, LLA resilience is expected to shine.

Development of UK Pension Risk Transfer Market
Source: Hymans Robertson

Diversification within the Longevity Risk Market:

Within the Longevity Risk Market, investors can diversify their portfolios by investing in different asset classes such as longevity bonds, longevity swaps, buy-ins and buyouts. There can be additional diversification within a specific asset class due to security characteristics such as the investment structure, index the asset is linked due, and more. Furthermore, issuers exposed to mortality risk can easily hedge their risk using LLA.

Attractive pricing and lower costs

Porfolio-specific indemnity index-based LLA offer attractive prices for multiple reasons. Index-based solutions have lower legal and administrative costs for issuers, reducing security pricing and attracting more players to the Longevity Risk Market. In addition, LLA typically have long time-to-maturity, further increasing market capacity. The higher the capacity and liquidity on the market, the more competition there is, further lowering prices. Lastly, the lack of correlation to the capital markets lowers volatility risk, allowing further pricing adjustments.

High-yield investments

LLA offer a competitive yield when compared to other fixed-income bonds and dividend stocks, and investors receive stable fixed-interest payments over the life of the bond, even when interest rates are low, such as the current interest environment. Most LLA pay a floating coupon, making them mostly immune to interest rate hikes through upside retention.

To summarize, LLA offer investors a resilient investment opportunity with the potential for high returns and a stable income, which are critical for portfolios in times like these. LLA are a fantastic diversifying tool for portfolios, limiting exposure to the financial markets and interest rate hikes. The market is expected to stably increase with investor appetite and cedents’ increasing need for longevity risk management.

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.