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Longevity risk, the chance that people will live longer than expected, is potentially very expensive. Never mind the dramatic impact of a cure for cancer: adding an extra year to the average lifespan increases the world"s pension bill by 4%, or around 1 trillion, according to the IMF.
Firms that have sold annuities are the most obvious victims of living longer, as they keep on writing cheques to oldies they expected would have passed on by now. But the most severe risk lies with defined-benefit pension schemes, in which participants are promised an annual payment throughout their retirement, however long it may last. Globally private defined-benefit schemes already have 23 trillion of liabilities—the amount they owe current and future pensioners. Many are grossly underfunded as it is.
Such statistics are enough to send a pension trustee to an early grave. Yet there is an apparent cure, in the form of "longevity swaps", which pension schemes can use to insure against the risk that their members will live longer than expected. In July, the pension scheme of BT, Britain"s former telecoms monopoly, which is wrestling with a deficit of 7 billion, offloaded the longevity risk on over a quarter of its liabilities to Prudential Financial, an American insurer. BT will pay Prudential a monthly fee and it in turn will pay the extra pension costs if the shuffle boarders in question live longer than forecast.
Such arrangements have become increasingly common, with 2014 already setting a record for liabilities offloaded in Britain, the centre of the market. BT"s deal, which covered pension debt worth 16 billion, was the biggest yet. Most of the 20-odd deals so far have been between big pension schemes and insurers such as Prudential and Swiss Re. The deals should help them hedge a risk they already have through their other businesses, which pay out if clients die unexpectedly early.
But the potential liabilities that need to beneutralised far exceed what insurers might want to take on. So new investors are being sought to take on risks associated with ever-older clients through "longevity" bonds, whereby outsiders take on the unwanted risks.