| Longevity Bond 101 |
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| 19/12/2004 | |
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Issuers are gearing up to meet demand from pension funds looking to hedge the longevity risk. One of the last instruments to hit the fixed-income market is the longevity bond, which could soon be followed by a 50-year bond issued by the British Government. 1-What is a longevity bond? The longevity bond is a 25-year bond issued by the European Investment Bank. The future cash flows of the bond are equal to the amount of a fixed annuity multiplied by the percentage of the reference population still alive at each anniversary. The cash flow calculations are based on the actual longevity experience of the English and Welsh male population aged 65 years old that is still alive at each anniversary date, as published annually by the Office for National Statistics (ONS). As such, the bond is an effective hedge for pension annuity liabilities because the future coupons on the bond (and hence the value of the bond), which should normally be declining over time, but that will increase if the Reference Population lives longer than expected. This increase in value of the Longevity Bond will offset the liability increases that are expected within a specific annuity portfolio if the Reference Population is living longer than expected Illustrative cash flows of the Longevity Bond based on the Government Actuary's Department (GAD) projections  Source : BNP Paribas 2-In what ways is it different from the 50-year bond that could be issued by the British government? In the event the British government issue those bonds, it is likely that they would not be linked to the actual longevity in any segment of the population, but simply pay a fixed amount every year. In turn, there may be no longevity protection at all. The profile and duration of the bonds would be different. In particular, the Government Bonds are unlikely to be specifically targeted at any segment of the population. 3-Which investors should be interested in this instrument? The main interested parties are UK defined benefit pension plans and insurance companies because both types of institution are exposed to longevity risk in the English and Welsh populations through their provision of annuities or pensions. The Longevity Bond is a cost-effective instrument available in the market today to help them to hedge these liabilities. (sources: bfinance, BNP Paribas) |
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