Swiss Re issued the unique bond in 2010, building on its experience of natural disaster and mortality catastrophe bonds and transferring the risk of extreme longevity risk to the capital markets.
In their recent paper, Modelling longevity bonds: Analysing the Swiss Re Kortis Bond, Cass academics Andrew Hunt and David Blake modelled and analysed the Kortis bond since it was issued.
Co-author of the research, and Director of the Pensions Institute, Professor David Blake said:
“The Kortis bond provides a new method of transferring extreme longevity risk from insurers and reinsurers to investors in the capital markets. As the prototype of a new breed of longevity-linked securities, it is important to be able to model and analyse it, so that the entire industry can learn and improve how to transfer these extreme risks more effectively and, so, better support the growing market for pension scheme de-risking.”
Professor Blake and Dr Hunt modelled the payoff of the bond using a number of recently developed modelling techniques. They looked at how the structure pioneered by Swiss Re could be adapted to meet the needs of longevity risk in other insurers. The research demonstrates that the underlying bond design is very flexible, and has the potential to be widely replicated and extended to allow more efficient transfer of longevity risk to the capital markets.
The bond came about because Swiss Re reinsured pensions and annuities in the UK and, if these pensioners live longer than expected, Swiss Re will have to pay out more. At the same time they covered a lot of younger people for life insurance in the US and if they live longer then they pay out less. The investor buys this principle at risk bond and if mortality rates in England and Wales decrease faster than the US then the investor loses money. If that doesn’t happen they get their money back plus a high rate of interest on the bond.
The Kortis bond builds on the structure of catastrophe bonds, which pay out less in the event of an earthquake, hurricane or epidemic, and apply the same design to changes in mortality rates.
Dr Hunt said:
“We are the first to model and analyse the bond since it was issued. Our study discusses its design features, models its payoff and analyses the different risk factors present using a number of recently developed techniques that allow for the correlations in mortality rates between different countries, and finally, considers how the Kortis structure can be adapted and extended in future.
“With the phenomenal growth of the pensions buy-out, buy-in and longevity swap market - almost £35bn in the UK in 2014 alone (according to Towers Watson’s De-risking Report 2015) - there has been a huge transfer of longevity risk - the risk of faster than expected increases in life expectancy - to insurers and reinsurers. In turn, the reinsurance market has started to investigate novel methods for managing this risk.”
The success of the pensions de-risking market ultimately depends on the willingness of reinsurers to manage longevity risk, and Dr Hunt and Professor Blake believe that issuing further Kortis-type bonds is essential to maintaining the current high rate of growth the longevity risk transfer market and the ability of companies to reduce and eventually remove this risk from their pension schemes in future.
Download Modelling longevity bonds: Analysing the Swiss Re Kortis Bond below
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