Longevity involves a financial risk for the providers of pension products in particular: if life expectancy forecasts are wrong and pensions and annuities have to be paid for longer than anticipated, this may jeopardise the sustainability of pension products (longevity risk – LR). In the case of countries where the proportion of occupational pension schemes is high, in particular, providers are therefore showing increasing interest in reducing their longevity risks by transferring them to insurers, financial institutions and the capital markets (longevity risk transfer – LRT).

Although LRT markets are at present too small to give rise to systemic concerns, in view of the enormous market potential and the growing interest of investment banks it is important that rules be drawn up in good time to prevent significant systemic risks arising. As is the case with credit risk transfer, with LRT there is also a danger of risk being built up and concentrated where it is least understood or wrongly priced, for example because of incorrect correlation assumptions. The financial crisis of 2008-2009 showed that credit risk transfer had resulted in risks being concentrated on a relatively small number of investors who were then unable to bear them. A further factor is that a large volume of transactions may result in it becoming increasingly unclear who actually holds the longevity risk. That also happened with credit risk transfers. In addition, when considering the LRT market it needs to be borne in mind that market participants might change their behaviour patterns in response to new supervisory regimes, especially Solvency II and the CRD IV/CRR (Capital Requirements Directive IV/Capital Requirements Regulation) package. But this is something that cannot be assessed yet.

The Joint Forum’s policy recommendations

The Joint Forum has therefore examined this subject, and it published a report on it in December 2013. This report describes the LRT market, investigates growth and development factors and assesses the potential risks from a cross-sectoral perspective. The report ends with eight policy recommendations for action aimed in particular at policymakers, regulators and supervisors.

Recommendations for supervisory authorities:

• Step up cross-sectoral and international communication and cooperation
• Ensure that holders of longevity risk have the necessary knowledge, skills, expertise and information
• Pay attention to tail risks

Recommendations for policymakers and regulators:

• Assess appropriateness of relevant policies
• Ensure appropriate qualitative and quantitative standards
• Ensure adequate risk-bearing capacity of institutions taking on longevity risks
• Monitor market developments
• Support and promote the compilation of longevity and mortality data

Interview with Thomas Schmitz-Lippert: “Enormous market potential”

Thomas Schmitz-Lippert is Chairman of the Joint Forum and Executive Director International Policy/Affairs of BaFin.

Mr Schmitz-Lippert, you are chairman of the Joint Forum, which has drawn up the policy recommendations on the transfer of longevity risks. Is this a subject that should worry us?

In order to avoid any misunderstanding, the report, with its recommendations, does not say that the transfer of risks associated with increasing life expectancy is already an enormous problem or will even trigger off the next financial crisis. But this market, which is still relatively young and therefore uncharted territory for us as well, does have the potential to influence the financial markets considerably. It is therefore important that political decision-makers and supervisors tackle the subject in good time and prevent things taking a wrong turn. It is at them that the Joint Forum’s policy recommendations are aimed.

Why was it the Joint Forum in particular that dealt with the subject?

The Joint Forum is – together with the FSB (Financial Stability Board) – the only global forum that examines cross-sectoral issues, i.e. matters arising from the growing interconnectedness of financial sectors and their regulation. The Joint Forum brings together supervisors from different countries and financial sectors and is therefore able to indentify potential risks early. We can make policymakers and supervisors more aware of these risks and seek solutions.

Is longevity not actually a purely insurance industry issue?

That may appear so at first glance. Longevity risks do of course concern pension funds and the insurance sector first of all. But for two or three years, though, investment banks have also been involved in high-volume transfers of longevity risks. This was also the reason why the Joint Forum took on the subject. Although in most countries banks are not allowed to assume longevity risks directly, they can do so indirectly by means of swaps. In this way a risk that is really limited to one financial sector is extended to other sectors or market participants and contributes to the financial system becoming even more strongly interconnected.

In what way may the transfer of longevity risk become a problem for the financial system?

If insurance risks are transferred to other markets, an interlinking between undertakings and financial sectors arises. In view of the enormous potential of this market, systemic risks might arise here. The high dependency on models and possible information asymmetries between investors and sellers of longevity risks are parallels with credit risk transfer. For retirement pension provision to remain stable, steps must therefore be taken in good time to prevent risks accumulating where may be least understood and least able to be managed. The basis for systemic stability is and remains transparency. It must be known who actually holds the risk and whether its risk-bearing capacity is always adequate.

In addition to this, what, in your opinion, are the most urgent topics on the Joint Forum’s agenda?

Very high on the agenda is also bound to be question of asset encumbrance. This issue has arisen primarily in connection with the banking sector. Possible cross-sectoral effects of new regulations for the insurance sector or the securities market, on the other hand, have not been examined very much up to now. Just think, for example, of the future supervisory regime for insurers, Solvency II, or EMIR, the European Market Infrastructure Regulation, which has meant major changes for OTC derivatives. But as a representative of an integrated supervisory authority, it is particularly important for me that the profile of the Joint Forum as a forum for cross-sectoral issues is further strengthened. Only in this way can we take adequate account of the growing interconnectedness in the financial sector – with a forward-looking perspective.

How does the Joint Forum obtain the information it needs for this?

The supervisors and regulators who comprise the Joint Forum can, of course, draw on the know how of their home-country authorities. In addition, we work closely together with the international standard-setters, and also with other parties involved internationally and nationally. We obtain the opinions of interested parties and consult on every report before it is published. We consider all opinions submitted and amend the reports if necessary. Frequently, private market participants are also involved in the reports.

Mr Schmitz-Lippert, thank you for granting us this interview.

Joint Forum

The Joint Forum is a joint body of global standard-setters: the BCBS (Basel Committee on Banking Supervision), the IAIS (International Association of Insurance Supervisors) and IOSCO (the International Organization of Securities Commissions). The Joint Forum was created in 1996 from its predecessor body, the Tripartite Group, which was founded in 1993. It is comprised of an equal number of senior banking, insurance and securities supervisors of the member states, which currently number 15, and is intended to support them in achieving their joint regulatory and supervisory objectives. The Forum regularly publishes reports, principles and recommendations that are aimed at national authorities, policymakers, supervisors or financial undertakings. The chair of the Joint Forum rotates every two years between the standard-setters. Thomas Schmitz-Lippert has chaired the Joint Forum since November 2012. He had been nominated by the IAIS. At the beginning of 2014 Schmitz-Lippert assumed the chair of the Joint Forum for a further two years, this time on behalf of the BCBS.