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Banks to develop ‘death’ derivatives Renée Schultes and Mike Foster
13 Nov 2006
BNP Paribas and Deutsche Bank are developing derivative products that pension funds could trade to hedge against the cost of supporting old people who live longer than expected.
The products, dubbed “mortality derivatives”, would provide pension schemes that have big deficits with an additional tool to manage the cost of servicing the shortfall.
Partha Dasgupta, chief executive of the UK government-sponsored Pension Protection Fund, hopes to see the development of a market for mortality risk. He said: “We’re trying to encourage the banks to co-operate. Assuming we can get the right pricing data, I don’t see why we shouldn’t have a fully functioning secondary market in five years.”
Market sources said Credit Suisse, which last year launched a longevity index based on US mortality data, looked at offering products linked to the index but had not gone ahead. It is also looking at launching a longevity index in Europe.
Investment consultants said a mortality swap, where a pension fund pays a fixed rate to receive protection against changes in mortality, was a likely outcome but cautioned against the bespoke nature of the data necessary to make this work.
Mark Azzopardi, head of insurance and pensions at BNP Paribas, said: “Creating the ability to trade is not particularly difficult. In any country where a governmental or other independent agency can provide reliable mortality statistics, it doesn’t take much to develop an index from that.
“We’ve done as much as we can until we see both sides of the market willing to trade.”
Azzopardi said the emergence of pension buyout companies, such as Paternoster and Synesis, was a positive move towards a tradeable market as they could be writers of swaps.
Cliff Speed, investment director at Paternoster, said: “It’s something we’ve been considering. We are taking on risk and are able to charge for that. We believe we’re best placed to price that.”
Others say pharmaceutical companies can expect to sell more products if people live longer and so may be prepared to take the opposite side of a swap.
Recent actuarial data shows longevity has increased dramatically in recent years. On average, men aged 60 can expect to live to 86. Women of the same age can anticipate reaching 89.
Banks redoubled their efforts to put together products after BNP Paribas was forced to pull a longevity bond last year. Investors did not like the bond because it did not cover the risk of people living beyond 90, due to the lack of precise statistics on mortality beyond that age. Rashid Zuberi, managing director in Deutsche Bank’s European insurance and pensions group, said now that the markets for interest rate and inflation swapped had matured, pension funds were looking to hedge longevity risk.
Last week, UK retailer Marks & Spencer said its pension deficit had widened 32% to £1.05bn because its members’ life expectancy had risen.
Crispin Lace, consultant at Watson Wyatt, said: “The concept is great but when you look at how it works it seems to all fall apart.”
An investment banker said: “We’ve looked at it but you’ve got the perennial problem of where to hedge. It’s a one-way market. You can offload mortality risk at a price but you’ve always been able to offload it to Prudential.”
