In a new report Moody's has noted the launch of the Longevity and Life Markets Association (LLMA), the non-for-profit venture to promote a liquid market for longevity and mortality-related risk transfer solutions, such as longevity swaps (STORM February 2010). "For insurers with sizeable exposure to longevity, such as large UK annuity writers (eg, Prudential, L&G) or US life insurance companies (eg, MetLife, AIG, Manulife, Principal), the transfer of longevity risk to capital markets is a plausible alternative to reinsurance - where capacity is limited - and a good opportunity to enhance their credit profile," the rating agency says.

Some capital markets-based longevity transactions have been launched with lukewarm success, Moody's observes. "Although longevity-based assets are uncorrelated to other asset classes, investors' appetite is limited as the structures are usually complex, making it difficult to evaluate the underlying risk it adds.

Moody's continues: "This is why the primary objective of the LLMA is to develop standardised products, focusing initially on longevity swaps, standardised valuation methods, and published longevity indices. The variety of players involved in this new project enhances the chances of the association' success when compared with previous initiatives. However, it will take time before investors become as confident in longevity risk as they are with catastrophe risk, for example. Longevity risk is a very long duration risk, and there is no consensus on longevity models, especially beyond a medium-term horizon (eg, ten years).

If a longevity risk transfer market develops, the rating agency suggests that it will be positive for primary insurers. "We think annuity writers in particular will have a good opportunity to enhance their credit profile, as their exposure to longevity risk is increasingly a drag on their credit quality. However, standardised products have the drawback of not providing a perfect hedge to an insurer, and these solutions will arguably only be of optimal use to insurers with very large portfolios and limited basis risk."

For reinsurers, the alternative capacity provided by capital markets will present additional competitive capacity, potentially placing downward pressure on prices, Moody's argues. However, it adds: "reinsurers will also be able to use the market capacity to transfer their own longevity risk and will have the ability to take on more risks themselves. It could also allow them to be more active in the reinsurance of smaller pension funds or insurers that are unable to directly tap capital markets."

MP