The New Life Market

DOIhttp://doi.org/10.1111/j.1539-6975.2012.01514.x
AuthorDavid Blake,Kevin Dowd,Guy Coughlan,Richard MacMinn,Andrew Cairns
Published date01 September 2013
Date01 September 2013
THE NEW LIFE MARKET
David Blake
Andrew Cairns
Guy Coughlan
Kevin Dowd
Richard MacMinn
ABSTRACT
The huge economic significance of longevity risk for corporations, govern-
ments, and individuals has begun to be recognized and quantified. By virtue
of its size and prevalence, longevity risk is the most significant life-related
risk exposure in financial terms and poses a potential threat to the whole
system of retirement income provision. This article reviews the birth and
development of the Life Market, the new market related to the transfer of
longevity and mortality risks. Wenote that the emergence of a traded market
in longevity-linked capital market instruments could act as a catalyst to help
facilitate the development of annuity markets both in the developed and the
developing world and protect the long-term viability of retirement income
provision globally.
INTRODUCTION
The start of the twenty-first century has witnessed the emergence of the “Life Market,”
the traded market in assets and liabilities linked to longevity and mortality.As one of
the world’s newest capital markets—and one that is of direct relevance to individuals
David Blake is Professor of Pension Economics and Director of the Pensions Institute, Cass
Business School. Andrew Cairns is Professor of Financial Mathematics at the Department
of Actuarial Mathematics and Statistics, Heriot-Watt University. Guy Coughlan is a mem-
ber of the management team at Pacific Global Advisors. Kevin Dowd is Professor of Fi-
nance and Economics, Durham Business School. Richard MacMinn is Edmondson-Miller
Professor in Insurance and Financial Services at Katie School, Illinois State University. The
authors can be contacted via email: A.J.G.Cairns@hw.ac.uk, Guy.Coughlan@PacificGA.com,
Kevin.Dowd@hotmail.co.uk, and Richard.Macminn@ilstu.edu
Disclaimer: Information herein is obtained from sources believed to be reliable but Pacific
Global Advisors does not warrant its completeness or accuracy. Opinions and estimates con-
stitute the judgment of the authors and are subject to change without notice. Past performance
is not indicative of future results. This material is provided for informational purposes only
and is not intended as a recommendation or an offer or solicitation for the purchase or sale of
any security or financial instrument and should not serve as a primary basis for investment
decisions.
© The Journal of Risk and Insurance, 2013, Vol. 80, No. 3, 501–557
DOI: 10.1111/j.1539-6975.2012.01514.x
501
502 THE JOURNAL OF RISK AND INSURANCE
and institutions in all countries—it has the potential to develop into a very large global
market.1This is because of the growing recognition that longevity risk is a huge risk
that is proving to be highly burdensome to those—corporations, governments, and
individuals—that have to bear it. It cannot be hedged in existing capital markets,
and although it can be transferred via the insurance markets, these currently lack the
liquidity to support a fully fledged traded market.
What was missing until recently were new financial instruments for transferring
longevity risk, together with the technology and tools to create a transparent, liquid
market (Loeys et al., 2007). Over the last few years, these missing ingredients have
started to emerge, as evidenced by the first publicly announced longevity derivative
transaction between investment bank J.P. Morgan and Lucida, a UK-based insurer,
which took place in January 2008 (Lucida, 2008) and a number of similar capital
markets and insurance-based transactions that have followed.
The traditional method of transferring longevity risk is through insurance and rein-
surance contracts. An important example of this is provided by pension plan buy-outs
that have become prominent in the United Kingdom since 2006. This is a segment
of the Life Market comprising annuity providers (insurers), pension funds, and rein-
surers. This kind of transaction involves the transfer of all risks, including longevity
risk and investment risk, from the pension plan to the insurance industry.This article
surveys the development of the Life Market, focusing in particular on the longevity
risk transfer segment of the market. In “Longevity Risk,” we discuss the problem
of longevity risk, distinguishing between so-called macro- and micro-longevity risk.
We review the traditional solution for dealing with macro-longevity risk in “The
Traditional Solution for Dealing With Macro-Longevity Risk.” We then consider the
requirements for capital markets to develop and grow (“Capital Market Solutions
1Although the Life Market can be regarded as the world’s first organizedlongevity-linked capi-
tal market, there are a number of historical examples of longevity-linked financial instruments.
These include:
Tontines: invented by the Neapolitan banker Lorenzo de Tonti in 1653. Each investor
paid capital into the tontine and received dividends while alive. When an investor died,
his or her share was reallocated to the surviving investors. This process continued until
there was only a single survivor. There was no return of principal. The government of
King Louis XIV of France became the first government to issue tontine bonds in 1689.
The first bond ever issued by the British government in 1693 was a tontine: the proceeds
were used to fight the Nine YearsWar against Louis XIV.Tontines were later banned in
the UK and a number of US states because they began to be used to defraud investors.
However,they are still legal in other countries. For example, the European Union’s First
Life Directive allows tontines if they are underwritten by authorized and regulated life
offices.
Sovereign life annuities: sold, for example, by the British government between 1808
and 1929 to members of the public.
Flower bonds: these are equivalent to a standard bond plus a life insurance policy.
They were issued by the U.S. government at a discount to enable their holder to pay
federal estate taxes on the holder’s death. The bonds were redeemable at par plus
accrued interest when the holder died. Flower bonds have not been issued by the U.S.
government since 1971.
NEW LIFE MARKET 503
FIGURE 1
Life Expectancy at Age 65 in England & Wales and the United States, 1960–2010
10
12
14
16
18
20
22
1960 1970 1980 1990 2000 2010
65 EW Males
65 EW Females
65 US Male
65 US Female
)sraey(
5
6 ega ta ycnatcepxe efil doireP
Source: J.P. Morgan LifeMetrics data.
for Macro-Longevity Risk”). Next, we consider the first generation of bond-based
capital market solutions for macro-longevity risk that have been tried so far (“First-
Generation Capital Market Solutions”). The lessons learned here have informed the
design of the second generation of derivatives-based capital market solutions, al-
though there remain barriers to further development (“Second-Generation Capital
Markets Solutions–Derivatives”). “The Micro-Longevity Risk Market” reviews the
micro-longevity risk market, while “Life Securitization” discusses life securitization.
Finally, we conclude in “Conclusions.” Appendix A examines the main mortality
forecasting models, while Appendix B lists some key organizations that have called
on governments to support the development of the Life Market.
LONGEVITY RISK
Life expectancy has been increasing in almost all the countries of the world.2
Figure 1 shows the experience for England & Wales and the United States. Male
life expectancy at 65 in England & Wales rose from 11.2 years in 1960 to 17.5 years
in 2010 or by around 1.1 percent per annum. By contrast, England & Wales female
life expectancy at 65 rose from 14.4 years in 1960 to 20.2 years in 2010 or by around
0.8 percent per annum. Figure 2 shows that, maximum life expectancy at birth for
females across developed countries has been increasing almost linearly at the rate of
nearly 3 months per year for more than 150 years.3
2There are only a few exceptions: a current example is Zimbabwe, where male life expectancy
at birth has fallen to 37 for males and to 34 for females.
3There is no sign of this trend abating according to a recent study: “Life expectancy in Europe
is continuing to increase despite an obesity epidemic, with people in Britain reaching an
older age than those living in the United States, according to study of trends over the last

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