Investors offered life-and-death bet on pension funds

Goldman Sachs, Deutsche Bank and JPMorgan Chase, which bundled and sold billions of dollars of mortgage loans, want to help investors bet on people's deaths.

Pension funds sitting on more than US$23 trillion ($29 trillion) of assets are buying insurance against the risk that their members live longer than expected.

Banks are looking to earn fees from packaging that risk into bonds and other securities to sell to investors.

The hard part: finding buyers willing to take the other side of bets that may take 20 years or more to play out.

"Banks are increasingly looking to offer derivative solutions," says Nardeep Sangha, chief executive of Abbey Life, a London-based unit of Deutsche Bank that helps pension funds manage the risk of retirees living longer than expected.

"Making the long maturity of the risks palatable for investors, including sovereign wealth funds, private-equity firms and specialist funds, is the challenge."

As insurers reach the limit of how much pension-fund liability they're willing to shoulder, companies such as JPMorgan and Prudential last year set up a trade group to establish and standardise a secondary market for so-called longevity risks.

They're also developing indexes that measure mortality rates and securities to let pension funds pay fixed premiums to investors in return for coverage against deviations from projections. Swiss Reinsurance, the second-biggest reinsurer, sold the world's first longevity bond in December in what it called a test case to sell risk to the capital markets.

Goldman Sachs, of New York, and Deutsche Bank in Frankfurt have set up insurance companies that promise to pay pensions if retirees live past a certain age.

They typically receive a portion of the pension plan's assets in return. "Ultimately, reinsurance capacity for longevity risks will run dry, and that's why it's imperative that as the market grows and develops it is able to bring in new types of risk-takers," Sangha says.

"The obvious channel is the capital markets."

Medical advances and healthier lifestyles have made predicting lifespans more difficult. Life expectancy in Britain is increasing by one to three months every year, according to Dutch insurer Aegon.

Every year of additional life expectancy typically added as much as 4 per cent to future pension requirements, Aegon said in a report.

Pension funds can hedge against life-expectancy risk by transferring assets to an insurer or other counterparty that promises to pay some or all of the future liabilities. Last year GlaxoSmithKline, Britain's biggest drug-maker, became the 10th FTSE 100 firm to buy insurance on about £900 million, or 15 per cent, of its British obligations.

That means Prudential, Britain's largest insurer, rather than the pension fund, will pay some GlaxoSmithKline pensioners should they live longer than expected.

Britain is the world's biggest market for insuring pension liabilities, after a change in accounting rules in 2004 forced companies to include pension plans on their balance sheets, increasing the volatility of earnings. Since then, £30 billion of liabilities have been insured, according to estimates by Hymans Robertson, a London pension consultant.

- Bloomberg