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No industry has borne the brunt of the world’s rapidly ageing population like life insurance.
As well as selling protection to family members against the premature death of a wage earner, these companies have built a healthy business insuring human lifespan.
Insurers take the savings of workers, promising in return to deliver a retirement income that can last for life. Yet with people living longer than ever before, it is more important than ever for them to get the longevity assessments right.
“It’s probably only the big pharmaceutical companies who rival our interest in understanding longevity,” says Kerrigan Procter, who runs the retirement business of FTSE 100-listed Legal & General.
On the one hand rising longevity is good news for insurers; they can sell protection against premature death much more cheaply than they once did. However, as pensioners live longer, the costs of promises made in earlier years threaten to eat into their profits.
“If you’ve only got a few years to cover there’s only so much you can be wrong,” says Paul Clark, insurance partner at the Boston Consulting Group.
“Pensioners used to live for just a few years after 65. If it could be 20 or 30 years, the potential for getting it wrong is much greater.”
Worse, insurance executives complain that actuaries have tended to underestimate longevity improvements. “Data about the past is not necessarily a good indicator about what will happen in the future,” adds Mr Clark.
Nor is the present particularly favourable. With interest rates near record lows, insurers are struggling to make good on payout promises and still turn a profit.
“If you’re in the business of providing long guarantees to customers, and people are living longer, it’s very difficult to do that with low yields,” says Paul Fulcher, managing director of asset liability structuring at Nomura.
Insurers are responding to the challenges in several ways. They have historically gathered relatively limited information about policyholders such as their age and gender. Now they are asking far more detailed questions.
They are looking at a greater range of lifestyle factors, such as patterns of exercise and alcohol consumption. They are employing increasingly sophisticated “big data” techniques to assess life expectancy and being far more granular in assessing the risk of each annuity holder. This is then reflected in the price.
The industry is also passing on risks to third parties. They have found other financial institutions and capital markets investors willing to take the other side of their gamble through products such as longevity swaps. If people live longer than expected, payments go from the investor to the insurer. But if the annuity holder dies sooner than forecast, they go the other way.
Regulation is also forcing insurance companies to rethink their business models. Tougher capital requirements are making it more expensive than ever for insurers to go on taking the longevity risk.
Over the past decade they have transformed their business models from bearing such risks on behalf of policyholders to managing assets on investments consumers make.
For instance, although still formally designated an insurer, Standard Life is set next year to generate only about 10 per cent of its revenues from products that involve it taking risks on its own balance sheet.
The trend is expected to accelerate, particularly in the UK, after regulatory changes that will give savers more flexibility in how they access their pension savings.
Although the challenges are formidable, there is a silver lining. The ageing population creates opportunities, not just risks: the ratio of workers to pensioners is forecast to more than halve over the next 35 years – from four to one to less than two to one, says L&G.
With fewer workers available to fund state and private pension schemes for people who have already retired, those who are still working will need to save more today to ensure they have income when they retire. Insurers are counting on a surge of savings to fuel their growing investment management businesses.
Insurance executives also forecast that cash-strapped governments will look to the industry as they struggle to pay the rising bill for care, health and other services for the elderly, as well as pensions.
“If things are bad now, what’s it going to be like in several years time?” says Ned Cazalet, the veteran financial services consultant. “Consumers should be nervous.”
Companies too are anxious. Having promised generous retirement benefits to their workers, many companies are looking for products that will help them manage the risk of workers who live far longer in retirement than they were ever expected to.
These are potentially lucrative opportunities for the insurance industry. But only if insurers succeed in assessing and managing longevity trends properly.
“I don’t look at longevity risks as a big problem for providers – though they’ve got to get their sums right,” says Mr Cazalet.
“There is a huge client need – people are going to live a long time and they’re going to need to get their money to work.”