Financial Aspects of Longevity Risk Gavin Jones Gavin Jones is a Strategy Research Actuary at Swiss Re, where he focuses on mortality risks undertaken by the reinsurer's Life & Health Business Group. Prior to joining Swiss Re in November 2004, he worked as Mortality Risk Actuary at Prudential UK where, writing in a personal capacity, he co-authored 'Financial Aspects of Longevity Risk' with Stephen Richards. Gavin Jones has a PhD in mathematics from Cambridge University and is a Fellow of the Institute of Actuaries. First international conference on longevity and capital market solutions 18 February 2005 Cass Business School, London

Financial aspects of longevity risk Page 2 Longevity liabilities are spread, in varying sizes, between insurers, the state and occupational schemes UK insurers wrote GBP 7.4 billion of new annuities in UK life insurers have GBP 70 billion 2 Public-sector pension schemes have GBP 580 billion 3 Occupational pension schemes have GBP 762 billion 4 1) Association of British Insurers, 2003 (figures exclude bulk annuities) 2) Richards and Jones, Financial aspects of longevity risk, Staple Inn Actuarial Society, ) Watson Wyatt press release, August ) Government Actuary’s Department, Eleventh Survey of Occupational pension Schemes, 2000

Financial aspects of longevity risk Page 3 Mortality basis has a significant impact on the calculation of longevity liabilities Male aged 60, fixed annuity at 5% Source: Longevity in the 21st Century, Willets et al, 2004

Financial aspects of longevity risk Page 4 Longevity risk is capital intensive, difficult to hedge and contains considerable financial risks Significant capital requirements apply to longevity risk The duration of liabilities can be long and uncertain Availability of reinsurance or other hedge for longevity exposure is limited Deferred annuities are dominated by unmatchable interest rate and inflation risk

Financial aspects of longevity risk Page 5 Longevity risk: shareholder exposure Company nameShareholder longevity liabilities GBP million 1 Prudential3.2 L&G11.0 BAE Systems11.2 British Airways11.2 Norwich Union11.5 BT29.1 1) Size of either (a) annuity liabilities or (b) pension scheme assets plus FRS 17 deficit. End-2003 figures

Financial aspects of longevity risk Page 6 Insurers are subject to different regulatory considerations from corporate pension schemes Insurers are discouraged from holding inadequate reserves (Financial Services Authority) Company DB schemes are discouraged from holding excessive reserves (Inland Revenue) – e.g. Maximum Funding Level for SSAPs is PA(90)-2 Disclosure of mortality bases not required of company DB schemes

Financial aspects of longevity risk Page 7 Longevity risk carries a range of uncertainties Basic statistical uncertainty – for 50 (i.i.d) annuities require 10% capital to fund to 99% confidence – 2004 Finance Act: pension schemes with fewer than 50 members must secure pensions as annuities – lowest risk portfolios are large with limits to size of benefits Anti-selection: impact of impaired market Mortality trend uncertainty

Financial aspects of longevity risk Page 8 Longevity risk: mortality improvements vs inflation

Financial aspects of longevity risk Page 9 Longevity risk: base mortality differentials (excluding future improvements) Differentiale 65Years Base case22.5n/a Female > male High > low status Short > long duration High > low income13.8 South > North12.8 Overalln/a-9.7

Financial aspects of longevity risk Page 10 Summary: financial impact of mortality on longevity risk Correct base mortality (up to 25%) Anti-selection effects (3%?) Mortality trend (3%?) Statistical uncertainty –size/heterogeneity of portfolio (2%?)

Financial Aspects of Longevity Risk Stephen Richards and Gavin Jones First international conference on longevity and capital market solutions 18 February 2005 Cass Business School, London