Thursday, January 31, 2008

Longevity Securitization

These days 401(k) investors are focused on what they perceive to be their largest risk ….the risk that that their investments will lose value. In fact, many are unaware that a much larger risk looms....longevity risk.

Longevity risk is the risk of either under-living or outliving their planned asset base/income stream. As the level of defined benefit plan, longevity- protected, distribution streams fade and the baby boomer cohort faces retirement, the demand for individual annuities, which address this risk, will probably increase. The adoption rate of retirement annuities will however, be influenced by; investor perception, pricing, insurance industry risk retention models and the state of the structured investment markets.

As demand for individual annuities increases, insurer’s capacity to handle this exposure is ultimately limited by a risk warehousing approach and by industry capital requirements. Just as the securitization phenomena allowed banks to increase their underwriting capacity and disintermediate mortage risk, so securitization of longevity risk could attract more capital and provide a lower priced more flexible annuity product than is available today.

Advancements in capital market solutions and tradeable indices for longevity risk could contribute substantially to defeasing one of the most significant risk transfers from the demise of the defined benefit retirement model.

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