Feel Like Betting On Life Expectancy? There's A Derivative For That

From ZeroHedge:

Think CDS were the scourge of humanity, think again. As Pension360 reports, several Wall Street firms are selling securities backed by longevity risk - the risk that retirees receiving benefits will live longer than expected (and thus incur a higher cost on their retirement plan). As Ted Ballantine notes, 'no one ever said Wall Street wasn't creative'; but one wonders just how the banks are mitigating this risk...



More from Institutional Investor:

Sovereign wealth funds, educational endowments and ultrahigh-net-worth individuals are the target investors for longevity derivatives, which package the risk that retirees drawing annuities will outlive actuarial expectations.

The roots of this nascent market date back to 2006, when small monoline insurance companies such as U.K.-based Lucida (purchased by Legal & General in June 2013) and Paternoster (bought by Goldman Sachs Group in 2011) began taking longevity risk off European pension funds through bulk annuity buyouts.

These buyouts entail a company selling pension assets earmarked for all or some of its plan participants. The assets are converted to annuities that the sponsor can keep on its books or off-load to the insurer.

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Banks build longevity derivatives products using risk models provided by firms like Newark, California–based Risk Management Solutions (RMS). They’ve closed a dozen such deals, but the customized structure can be tough for investors to grasp. Deutsche Bank is focused on creating a path into the capital markets, according to Paul Puleo, global head of pension and insurance risk markets in New York.

In December 2013, Deutsche created longevity experience options, or LEOs, a more standardized product tailored to capital markets participants. Longevity derivatives resemble the older catastrophe bond, or insurance-linked security (ILS), market, which packages insurance against natural disasters. A key difference between longevity insurance derivatives and cat bonds is that there are now a number of hedge funds dedicated to the ILS market.

Who buys these securities? It’s been mostly life insurers so far. But firms anticipate other interested parties will soon be buying up these instruments, as well....MORE