Mortality bonds and longevity bonds

You can bet on people dying: Liam Pleven and Ian McDonald in the WSJ have a good overview of how life-insurance companies are increasingly turning to the capital markets to hedge the risks they bear of insured individuals dying too soon. But can you bet on people living? The power team of Gillian Tett and Joanna Chung in the FT has a long and fascinating article about the other side of the coin: bonds issued by pension companies to hedge the risks of annuity holders, say, living too long.

The big problem is that at the moment all these instruments are largely targeted at sophisticated hedge funds, who want such large expected returns that issuance simply doesn't make sense for the life insurers and the pension companies. In fact, a spate of mergers between pension companies and life insurers makes much more sense, since then the risks tend to cancel each other out. But such mergers aren't easy: life insurers make their money by being constructive on mortality, while pension companies take the opposite view.

All the same, I've long been surprised at how unpopular annuities are. Pension plans usually wind up giving a recently-retired person a lump sum, and it would seem to make all the sense in the world to simply convert that lump sum into a guaranteed payment for life. But relatively few people do that, and so they run the risk of outliving their money. Maybe what's needed is a combination annuity and health insurance product, which guarantees not only an income but also to pay all those dreadful medical expenses which can arise at the end of life. But there are precious few companies with the breadth of expertise to offer such a thing. Cue further insurance-industry consolidation!

Posted by Felix at 14:39 EST

Comments

This has surprised me, as has the apparent fact that fixed annuities that are indexed to inflation seem to be even less popular than those that aren't. (I believe the former are, now, at least available, where ten years ago it may have simply been impossible for the average consumer to find them.)

Anyway, shouldn't these things be poolable and tranchable so that you could get hedge funds interested in the leveraged risk and your traditional institutional investors interested in the safer tiers? Insofar as I'm envisioning something specific, it looks like a planned-amortization tranche and a residual.

Posted by: dWj at 20:12 EST, February 28, 2007

Re: annuities combined with health care. Former assistant Treasury secretary Mark Warshawsky, now at Watson Wyatt, has proposed combing annnuities with long-term care insurance. There were some significant tax and legal barriers to doing this, but a provision in the recent Pension Protection Act fixes that, I think.

Posted by: Pat Regnier at 15:11 EST, March 02, 2007