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Goldman Sachs, Deutsche Bank and JP Morgan Chase will help investors to BET on the Death of Pensioners

Posted on: May 20, 2011

Goldman Sachs Group Inc. (GS), Deutsche Bank AG (DBK) and JPMorgan Chase & Co. (JPM), which bundled and sold billions of dollars of mortgage loans, now want to help investors bet on people’s deaths.

Pension funds sitting on more than $23 trillion of assets are buying insurance against the risk their members live longer than expected. Banks are looking to earn fees from packaging that risk into bonds and other securities to sell to investors. The hard part: Finding buyers willing to take the other side of bets that may take 20 years or more to play out.

“Banks are increasingly looking to offer derivative solutions,” said Nardeep Sangha, 43, chief executive officer of Abbey Life Assurance Co., a London-based Deutsche Bank unit that helps pension funds manage the risk of retirees living longer than expected. “Making the long maturity of the risks palatable for investors, including sovereign wealth funds, private-equity firms and specialist funds, is the challenge.”

As insurers reach the limit of how much pension-fund liability they’re willing to shoulder, companies such as JPMorgan and Prudential Plc (PRU) last year set up a trade group aimed at establishing and standardizing a secondary market for so- called longevity risks. They’re also developing indexes that measure mortality rates and securities to let pension funds pay fixed premiums to investors in return for coverage against major deviations from projections.

Swiss Reinsurance Co., the second-biggest reinsurer, sold the world’s first longevity bond in December in what it called a “test case” to sell risk to the capital markets.
‘Run Dry’

Goldman Sachs, based in New York, and Deutsche Bank in Frankfurt have set up insurance companies that promise to pay pensions if retirees live beyond a certain age. They typically receive a portion of the pension plan’s assets in return. The banks, along with Morgan Stanley (MS), Credit Suisse Group AG (CSGN) and UBS AG (UBSN), are looking for ways to offer this risk to investors.

“Ultimately, reinsurance capacity for longevity risks will run dry, and that’s why it’s imperative that as the market grows and develops it is able to bring in new types of risk-takers,” Sangha said. “The obvious channel is the capital markets.”

Medical advances and healthier lifestyles have made predicting life spans more difficult for pension funds. Life expectancy in the U.K. is increasing by one to three months every year, according to Dutch insurer Aegon NV. (AGN) Every year of additional life expectancy typically adds as much as 4 percent to future pension requirements, Aegon said in a report in March.

Aegon reported last week that first-quarter profit fell 12 percent as the company set aside money to cover the risk of policyholders in the Netherlands living longer than expected.
Glaxo Transfer

Pension funds can hedge against life-expectancy risk by transferring assets to an insurer or other counterparty that promises to pay some or all of the future liabilities. Last year, GlaxoSmithKline Plc (GSK), the U.K.’s biggest drugmaker, became the 10th FTSE 100 firm to buy insurance on about 900 million pounds ($1.5 billion), or 15 percent, of its U.K. obligations.

That means Prudential, the U.K.’s largest insurer, rather than the pension fund, will pay some GlaxoSmithKline pensioners should they live longer than expected. Most longevity risk transferred from pension funds is held by insurers.

Regulators are just beginning to focus on the new products.

“We’re seeing more and more sophisticated mechanisms being offered,” said Bill Galvin, CEO of the U.K.’s Pensions Regulator. “From a regulatory perspective, we are concerned to ensure that trustees understand the extent to which longevity risk has been passed from their scheme and the precise shape of any residual risk.”
‘Early Days’

The Frankfurt-based European Insurance & Occupational Pensions Authority isn’t reviewing longevity transfers, said Sybille Reitz, a spokeswoman for the organization, because “the market is still in its early days.”

The U.K. is the world’s biggest market for insuring pension liabilities after a change in accounting rules in 2004 forced companies to include pension plans on their balance sheets, increasing the volatility of earnings. Since then, 30 billion pounds of liabilities have been insured, about 3 percent of the total outstanding, according to estimates by Hymans Robertson LLP., a London-based pension consultant.

Banks and insurers completed a record 8.2 billion pounds in longevity-risk transfers last year. Goldman Sachs-owned Rothesay Life Ltd. sold the most pension-plan insurance in 2010, while Deutsche Bank’s Abbey Life completed the biggest swaps deal.
Longevity Risks

With $17 trillion of the $23 trillion in pension-fund assets worldwide exposed to longevity risks, according to Zurich-based Swiss Re, investment banks see this as an opportunity to create a new market for those willing to bet on life-expectancy rates. If pensioners die sooner than expected, investors profit. If they live longer, investors must compensate the pension fund for the additional costs it faces.

Investors may be attracted to such bets because longevity trends aren’t linked to movements in equities, bonds or commodity markets, said David Blake, director of the pensions institute at Cass Business School in London, who has worked with JPMorgan on the derivatives.

The complexity and risk involved in longevity assets with timelines of more than 20 years means banks are looking to create bonds that offer 5 percent to 9 percent in annual returns, according to Guy Coughlan, former head of longevity structuring at JPMorgan. Returns as high as the “mid-teens” are possible, he said.
‘Structural Problems’

Investors remain unconvinced. Not knowing whether a bet on a group of pensioners’ life spans is correct for decades prevents hedge funds such as London-based Leadenhall Capital Partners LLP from entering the marketplace.

“There are big structural problems with the longevity market,” said Luca Albertini, CEO of Leadenhall, which has $120 million under management and invests in insurance-linked securities such as catastrophe bonds used to help cover hurricanes and other extreme risks. With clients able to withdraw investments only every month or quarter, “the only way I can invest is if the market is truly liquid,” he said. “No one has proven that to me yet.”

Subprime mortgages sold in the past decade were the genesis of the biggest financial meltdown since the Great Depression. Investment banks passed the risk of borrowers defaulting to the capital markets by packaging, or securitizing, the loans into bonds and selling them to investors and one another.
‘Fully Collateralized’

Collateralized debt obligations were created and sold in such volume that when mortgage holders defaulted, governments in the U.S. and Europe had to bail out the financial system. Banks are now looking to investors in much the same way to securitize the risk of pensioners living longer than expected.

Securities based on life expectancy don’t hold the same risks as those linked to subprime mortgages because they are “fully collateralized,” minimizing the risk from a counterparty failing to meet its obligations, Coughlan said.

Cass Business School’s Blake said it’s unfair to compare the securitization of mortality expectations to the subprime- mortgage market.

“Subprime was highly leveraged,” Blake said. “This is different.”

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