The World is Very Long on Longevity Risk

Longevity risk is clearly a huge growth market.  One has to wonder, though, where the capacity to address this market opportunity will come from.

When looking at the big picture, it is clear that the world has built itself an enormous long position in longevity risk.  In other words, there is an extreme imbalance between the amount of longevity risk on the balance sheet and the ability to absorb or fund this risk.

Consider the scope of the issue:

• Total pension liabilities exceed $19 trillion in the United States.
• Total pension liabilities exceed $3 trillion in the United Kingdom.
• Pension liabilities for the 23 million current and retired public-sector employees in the United States are estimated to be as much as $2 trillion.
• Unfunded Social Security liabilities are roughly $17 trillion.
• May as well throw-in Medicare liabilities since there is a clear correlation to longevity: another $80 trillion or so.

All of these liabilities are long duration.  In other words, these liability values are very sensitive to changes in mortality rates. 

Currently, life expectancy in the United States is increasing at a rate of 1.4 years per decade.  It is estimated that a 1 year increase in life expectancy translates into a 3 percent increase in liabilities.  Given the numbers above, it is simple to see that longer life-spans translate into many trillions of dollars of additional liabilities.

Who is going to provide the funding and sit on the other side of this trade?

The taxpayer—whether willing or not—is clearly on the hook since governments have so much longevity risk on their balance sheets.  

Inflation is certainly an option for governments since it erodes the real value of the obligations (assuming they are not inflation adjusted).  Deflation, however, would be catastrophic for governments since it has the opposite effect.

From a private sector perspective, life insurance companies, defined benefit pension plan sponsors, reinsurers and some capital markets participants provide various types of protection.

The issue in the private sector, though, is one of financial capacity.  Consider MetLife which is the largest life insurer in the United States.  A rough proxy for MetLife’s capacity is the value of its shareholder equity.  That value is current around $30 billion—clearly not enough to even scratch the surface of the entire problem.

The Life and Longevity Markets Association was recently formed by a consortium of banks and insurers.  Like it or not, expect more capital market, derivative-based solutions such as longevity swaps since conventional private sector approaches are outmatched.