Living Longer At What Price- Incorporating Longevity into a Risk Management Model
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Living Longer At What Price- Incorporating Longevity into a Risk Management Model






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Living Longer At What Price- Incorporating Longevity into a Risk Management Model Living Longer At What Price- Incorporating Longevity into a Risk Management Model Presentation Transcript

  • 8th July 2008Living Longer – At What Price?Incorporating Longevity Into A Risk Management Model
  • Longevity RiskPractical ApplicationsContentLongevity Risk AnalysisContentsRisk Components 3VaR Road Map 5Risk Type Analysis 12Hedging Ratios 15LE01 Analysis 18Redington Analysis 212
  • Incorporating Longevity Into A RiskManagement ModelRisk Components3
  • Longevity RiskPractical ApplicationsRisk Components There has been major focus onmarket risk in pension schemeresulting a significant de-riskingactions including asset allocationsto bonds and LDI. However, a full approach to risksshould include analysis oflongevity risk and integration intothe whole risk budget. Having removed “unrewarded”asset risks by hedging inflation andinterest risk typically leaves equityand longevity risks as the principalresidual risks.Longevity Risk AnalysisRisk Components4
  • Incorporating Longevity Into A RiskManagement ModelVaR Road Map5
  • Longevity Risk AnalysisVaR Definition6Value-at-Risk (VaR) – a Measurement of Market Risk• Value-at-Risk (VaR) provides a single amount (the value) which one might expect to lose (atrisk) in a reasonable “worst case” scenario, i.e. in one year’s time. As a general rule,Pension Schemes often use a figure which provides a 1-in-20 confidence level (95% VaR).VaR 95
  • VaR Roadmap Without considering longevity risk19.24%8.49% 1.83%7Longevity Risk AnalysisVaR Roadmap
  • VaR Roadmap including Longevity Risk8+0.68% (increased by 3.5%)+3.66% (increased by 200%)+1.45% (increased by 17%)Longevity Risk AnalysisVaR Roadmap
  • VaR Roadmap with Longevity Risk Hedged9*Assumptions:Longevity risk = 5.17% generic pension schemeLongevity basis risk remaining = 1%Longevity Risk AnalysisVaR Roadmap
  •  Adding longevity risk to VaR requires an assumption about correlation with other risk factors. We have assumed zerocorrelation. By modelling longevity risk under the CBD model, and given 0 correlation with other risk factors, the total VaRequates to As the total risk drops, longevity risk will dominates.VaR Road Map10Longevity Risk AnalysisVaR Roadmap
  • VaR Road Map11Longevity Risk5.17%Market Risk19.24%Total Risk19.92%Original Total Risk19.92%Longevity Risk5.17%Market Risk8.49%Total Risk9.94%Integrating longevity risk into overall risk analysisincreases the total risk by 3.5% of original marketrisk.But after hedging all interest and inflation risks,the longevity component increases the total riskby 17.1% of the original market risk.Longevity Risk AnalysisVaR Roadmap
  • Incorporating Longevity Into A RiskManagement ModelRisk Analysis by Type12
  • Risk Type Analysis Without including Longevity Risk:Longevity Risk AnalysisPractical Applications• Typical risk analysis shows the contributions to total risk of portfolio by risk type.•This graph shows risk contribution without considering longevity risk.13
  • Risk Type Analysis With Longevity:Longevity Risk AnalysisPractical Applications• Longevity risk on its own has 1-in-20 (VaR95) chance of increasing the liabilities by 5.17%.• Assuming zero correlation between longevity risk and other risk types, total risk attributable tolongevity increases by 0.53%.•Monte-Carlo simulation is not practicable as for other risk components. So general populationdata from ONS is adopted to quantify model (CBD) volatility for our analysis.14
  • Incorporating Longevity Into A RiskManagement ModelHedging Ratios15
  • Longevity Risk AnalysisHedging Ratio The table below shows that changes in mortality assumptions can have a significant impact onthe PV and Duration of a pension scheme’s benefits.*E.g. The PV for this specific scheme (calculated with a Long Cohort / 2% Underpin mortality table) is13% greater than the PV calculated using “92” table. The duration increases by 13.5%.Scenario Tests with Different Deterministic Mortality TablesActive Deferred Pensioners TotalPV(£ million)Duration(year)PV(£ million)Duration(year)PV(£ million)Duration(year)PV(£ million)Duration(year)"92" 195 26.8 195 25.5 598 11.1 988 17.0SC 196 26.9 197 25.6 605 11.2 998 17.1SC 1% 201 27.5 201 26.1 613 11.4 1,015 17.5SC 2% 216 29.3 218 27.8 641 12.3 1,075 18.9MC 200 27.2 201 25.9 619 11.4 1,020 17.4MC 1% 204 27.8 205 26.4 626 11.6 1,035 17.7MC 2% 218 29.4 220 27.9 648 12.4 1,086 18.9LC 209 28.0 210 26.6 648 12.0 1,067 18.0LC 1% 212 28.5 214 27.1 652 12.2 1,078 18.3LC 2% 223 29.8 225 28.3 666 12.7 1,115 19.316AccountingbasisTPR newproposal
  • Impact of Longevity Risk to Asset Liability Management:•Consider generic pension schemewith £1bn pensioner liabilitieswhose duration is 11 years.•Assume 100% interest rate andinflation hedging on “MediumCohort” mortality assumptions.• If actual mortality experience is“Long Cohort”, present value andduration of liabilities will increase.• The liabilities’ PV01 will be around13% higher than swap PV01 forboth interest rate and inflation. i.e.Actual hedging ratio declines from100% to 89%.17Longevity Risk AnalysisHedging Ratio
  • Incorporating Longevity Into A RiskManagement ModelLE01 Analysis18
  • Table 1: Sensitivity to 1 year rise in life expectancy for individual memberLE01 Analysis – Results – Which members represent the balance of risk?19• This table shows the liability increase for a single member in each of these categories given anincrease in life expectancy of one year (LE01).• LE01 analysis identifies the group of members with greatest longevity sensitivity and hence helps thescheme to decide which group should be first candidate for buy-out or hedging.• Members with highest age and final salary exhibit the greatest sensitivity.• However, in order to be meaningful this data has to be measured against actual number of membersin scheme.Longevity Risk AnalysisLE01 AnalysisAge/Salary 15K-30K 30K-45K 45K-60K 60K-75K 75K-90K 90K-105K 105K-120K 120K-135K 135K-150K 150K-165K 165K-180K 180-19525-35 465 775 1,085 1,394 1,704 2,014 2,324 2,634 2,944 3,254 3,563 3,87335-45 1,945 3,242 4,539 5,836 7,133 8,430 9,726 11,023 12,320 13,617 14,914 16,21145-55 4,176 6,961 9,745 12,529 15,314 18,098 20,882 23,667 26,451 29,235 32,020 34,80455-65 7,486 12,477 17,468 22,459 27,450 32,441 37,432 42,422 47,413 52,404 57,395 62,38665-75 11,810 19,683 27,556 35,430 43,303 51,176 59,049 66,922 74,796 82,669 90,542 98,41575-85 13,358 22,263 31,169 40,074 48,979 57,884 66,790 75,695 84,600 93,506 102,411 111,31685-95 14,614 24,356 34,099 43,841 53,584 63,326 73,069 82,811 92,554 102,296 112,039 121,78195-105 15,414 25,691 35,967 46,243 56,519 66,795 77,072 87,348 97,624 107,900 118,177 128,453105-115 15,679 26,131 36,583 47,036 57,488 67,941 78,393 88,845 99,298 109,750 120,202 130,655
  • LE01 TableLE01 Analysis – Results – Which members represent the balance of risk?20• This table shows the increase in the value of the liabilities due to one year increase in life expectancyfor the entire group of members.• The group of members aged between 55-75 receiving pensions of £45 – 90k p.a. is most sensitive tolongevity, which shows an increase of over £8m due to 1 year rise in life expectancy for the membersin this group.• Therefore, the group with the highest age and pension does not necessarily exhibit the highestLE01. That depends upon the age and benefit distribution of the scheme.Longevity Risk AnalysisLE01 Analysis
  • Incorporating Longevity Into A RiskManagement ModelRedington Analysis21
  • Session Overview:SolutionsFull Buyout Partial Buyout Partial InsuranceStandardizedHedgeCustomizedHedgePortfolioOptimizationAsset Liability ModellingLongevity Risk Integration Longevity VaR Roadmap Longevity Risk Impact AnalysisStochastic Liability AnalysisStochastic Model Calibration Stochastic Cashflow Analysis Quantify Longevity RiskDeterministic Liability AnalysisScenario Analysis LE01 AnalysisSocio EconomicGroupingScheme SpecificMortality AnalysisComplianceLongevity Risk AnalysisRedington Analysis
  • 23Redington AnalysisDeterministic Review Stochastic Model Optimized SolutionsLongevity Risk AnalysisRedington Analysis
  • BulkAnnuity/PurchaseAnnuities e.g.AIG/AEGON• Equity• Private Equity• Properties60% Equity 40% Bonds>70 years old 50 – 70 years old < 50 years old£X to reachannuitization triggerswith 95% confidence£Y to reach 110%funding underFRS17LONGEVITYANALYSIS60% fixed income +Swaps overlay40% alternatives24Redington Partial Annuitisation RoadmapLongevity Risk AnalysisRedington Analysis
  • Buyout Cost vs. Accounting Cost25• Buy-out quotations vary greatly. This graph is an illustration of buyout cost breakdown.Longevity Risk AnalysisRedington Analysis
  • Stochastic Mortality AnalysisTwo-Factor CBD Model PV(£’000,000)Mean 1,002S.d. 3295% 1,0545% 954LVaR 52As % of Total Liability 5.17%Buyout Cost due toLongevity1,045• Stochastic mortality models allow us to• estimate the likelihood of a given longevity-related scenario.• plot the distribution of liability values and quantify associated longevity risk.• measure effectiveness of longevity hedging relative to other risk mitigation.• calibrate buyout offer parameters.BuyoutCost due toLongevityLongevity Risk AnalysisRedington Analysis
  • ContactsDawid Konotey-Ahulu | Partner Direct: +44 (0) 207 250 3415dawid@redingtonpartners.comRobert Gardner | Partner Direct: +44 (0) 207 250 3416robert.gardner@redingtonpartners.comRedington Partners LLP13 -15 Mallow Street London EC1Y 8RDTelephone: +44 (0) 207 250 3331www.redingtonpartners.comTHE DESTINATION FOR ASSET & LIABILITY MANAGEMENTContactsDisclaimerDisclaimer For professional investors only. Not suitable for private customers.The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussionpurposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that theparameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appearabove are not necessarily indicative of future exchange rates, interest rates, or other reference rates or prices. Neither the information, recommendations or opinions expressedherein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf. Unless otherwise stated, any pricing information in this message isindicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs. Any reference to the terms of executedtransactions should be treated as preliminary and subject to further due diligence .Please note, the accurate calculation of the liability profile used as the basis for implementing any capital markets transactions is the sole responsibility of the Trustees actuarialadvisors. Redington Partners will estimate the liabilities if required but will not be held responsible for any loss or damage howsoever sustained as a result of inaccuracies in thatestimation. Additionally, the client recognizes that Redington Partners does not owe any party a duty of care in this respect.Redington Partners are investment consultants regulated by the Financial Services Authority. We do not advise on all implications of the transactions described herein. Thisinformation is for discussion purposes and prior to undertaking any trade, you should also discuss with your professional tax, accounting and / or other relevant advisers howsuch particular trade(s) affect you. All analysis (whether in respect of tax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon asaccurate.27