Longevity as transferable ‘risk’: the new financial dynamics of ageing

Giselle Datz - Associate Professor of Government & International Affairs, Virginia Tech, USA

Insofar as many DB schemes have accumulated deficits given historically low interest rates, reduced investment returns, and growing costs, a ‘longevity shock’ can impair their competitiveness. There is hence an incentive for companies that still offer DB pensions to move longevity risk off their books, particularly in Europe given Solvency II’s requirement that firms hold a risk margin relative to reinsured liabilities.

Since 2006, insurers, banks and investment experts have designed what they call ‘de-risking’ deals, allowing employers to shed some or all of their pension liabilities for a price. As of 2016, £280 billion in DB pensions risk have been transferred in the UK, US and Canada. The UK is unquestionably the pioneer in this market and concerns have emerged that the capacity of insurers and reinsurers may be reaching capacity relative to demand from pension schemes.

One de-risking strategy is a buy-in or longevity swap through which the employer buys ‘insurance’ against employees living longer than expected. Although the employer is still responsible for paying pensions, longevity risk falls in the hands of an insurer or bank on the other side of the transaction. A more elaborate deal that can be cut between a DB pension provider and insurance companies is known as a buy-out. Through it, the employer farms out all its pension obligations (both assets and liabilities) to the insurer who becomes responsible for pension payments. Individual benefits paid to retired workers remain the same in either buy-outs or buy-ins. The goal is to improve the stability of the pension scheme and consequently of the company that sponsors it.

Longevity risk transfers between DB pension schemes and insurance companies are a novel empirical element in the increasingly layered private pensions landscape. They expand the range and nature of retirement risk shifts, and consequently demand a better understanding of their distributive impact.

Analyses of risk production and transfer have long been part and parcel of analyses of global finance. Financial ‘risk’ and the ‘complexity’ to which it is associated are often products of agency and deliberate design. They are endogenous to the ever-expanding industry of ‘risk management’ that attempts to conquer volatility, complexity, indeterminacy through more refined techniques for calculation and computation.

Yet, as the 2007-08 financial crisis made all too clear, risk diversification and new hedging instruments (like credit default swaps) were not only ineffective in averting simultaneous losses from (what were perceived to be) ‘uncorrelated’ financial bets when the housing bubble started to burst, but these very diversification efforts and hedging moves intensified the meltdown.

Longevity risk, however, is different and refers to an exogenous (demographic) element in financial production. And risk transfers in this case, although certainly motivated by the ambition to increase profits (or reduce losses), are not the result of securitization processes made for their own sake.

There is a clear social element in these deals, regulated and incentivized by supervising authorities given the aim to help employers manage risks and hence safeguard pension security.

Yet, akin to the concerns raised by the financial crisis, ‘de-risking’ strategies are misnomers. Shifting risk may make individual companies safer at a microprudential level, but a series of transactions involving a limited number of longevity risk ‘buyers’ (insurance and reinsurance companies) may produce more risk concentration at one of the links in the financial system chain, raising macroprudential concerns.

We are indeed only starting to question how existing institutions and strategies can be ‘re-tuned’ to tackle new retirement investment needs, and the extent to which a radical new way of thinking about work, intergenerational exchanges, and solidarity will be called for and made viable. Among many indeterminacies, it is certain that condemning one of humanity’s greatest feats (increasing longevity) as a burden rather than benefit would mark a monumental wasted opportunity.