The predecessor to GRS,
Giuffre Associates, was founded in 2005 and worked within the risk research and
development space for three year. During this R&D period several products
were produced including a longevity risk derivative for which patent application
was filed in January 2006 (for a collateralized longevity swap); long before
the Credit Suisse- Babcock longevity swap in 2009 and current pension longevity
swap in the UK.
Using analytical and
structuring capabilities, LRS is able to translate between counterparties,
provide transparency, and understand the economic value created by risk
solutions. In 2010, LRS sought out an “MGA like" alliance, with a reinsurance
carrier to underwrite life related risk (i.e. longevity and mortality risk) in
a variety of target markets (such as life settlements, pensions, annuity books,
charitable gift annuities, long-term care, etc.).
LRS achieves greater
operating efficiencies by streamlining the risk delegation process and
utilizing proprietary technologies. LRS is thus able to pass on the benefits of
the efficiencies to the transaction counterparties.
In addition to premises that
capital market methodologies can be applied to other risks outside the credit risk
and market risk arenas and the componentization of particular capabilities can
create significant efficiencies, LRS believes that the risks (e.g. risks
associated with pensions, long-term healthcare contracts) are inter-related
and can be broken down into solvable components.
Risk Disaggregation Example:
Pensions
Pensions risk can be broken down into
o Payment amount risk
o Investment risk
o Longevity risk
Payment amount risk exists prior to the determination of the amount of
the individual pensioner’s benefits. For example, if pension payments increase
with years of service, then the amount cannot be known until retirement.
Investment risks are associated with the amount of pension assets. A
key concern of those managing pension assets is whether the amount of those
assets and the investment return on those assets will be sufficient to meet the
pension’s payment obligations. They must also monitor whether or not
asset/liability matching is appropriate so that there will be sufficient cash
available for the pension to make the actual payments at the point in time when
they are due. Investment related risks also involve market risks inherent in
the pension’s investment portfolio.
Longevity risk is the volatility associated with knowing the exact
number of times the pension will actually make the payment to a pensioner (e.g.
120 payments over 10 years) applied to all pensioners within the pension. Even
small changes in life expectancy (LE) can have an enormous financial impact. For
example, adding one year to a pension’s average LE can create under-funding
concerns and subsequently impact the parent organization’s profitability and
stock price. Longevity risk is reduced by entering into a longevity risk
transfer transaction that locks in the number of payments to be paid to each
pensioner, eliminating the unknown. Accordingly, transferring the financial
consequences associated with pensioners potentially living longer than expected
creates a more predictable environment.
Summary: The ability to hedge longevity risk can
make it possible for the pension to address other issues associated with
managing investment risks such as duration, asset / liability matching, and can
enable more effective investment strategies. Hedging longevity risk can also be
used to facilitate pension buy-outs, or can be used in conjunction with other
solutions designed to address under-funded pensions or provide employees with
new benefits.
Longevity Risk and
Solution Execution Concerns
The volatility
associated with longevity risk has the potential to affect an entity’s
shareholder value by impacting its strategic opportunities and financial
performance. Without a viable longevity hedge, protection buyers have
been primarily relegated to mitigating the financial consequences of longevity
risk by earning higher investment returns to sufficiently offset or cover-up
the volatility, or by defensively pricing the risk into their business models, products,
assets, and transactions (such as pension reserves or buyouts, reverse mortgage
origination, long-term and continuing care contracts, life settlement
portfolios, etc.).
LRS also addresses execution
related issues:
Correlation / Basis Risk
Many financial institutions are pushing for the
use of a proprietary longevity index. The premise behind the use of such an
index is that organizations will enter into transactions and trade contracts
based on the index as a hedge against their exposures. The problem inherent in
this approach is that it is predicated upon the protection buyer (such as a
pension) continuing to hold basis risk. The index is based on a specific
population, like a pool of 100,000 US or European residents. While these products may protect against an overall shift (i.e. a systemic change) they are not premised solely upon the protection buyer's cohort. These product offerings do not address the individual protection buyer’s
problem.
Accordingly, protection buyers need protection for a group of specific individuals whose experience will not necessarily correlate to the index (referred to as “correlation” or “basis risk”). With LRS, the protection buyer will not have correlation risk, as the transaction is based on the actual census provided by the protection buyer. For example, the specified population can be the actual retirees within a protection buyers’ pension.
Product Familiarity
LRS is able to utilize numerous longevity risk transfer structures. Reutilizing existing products/structures allows LRS to offer solutions that are familiar. One of LRS’s risk transfer vehicles is a capital market based longevity swap. As a result, during the duration of the transaction, the protection buyer’s payments are fixed, regardless of whether or not the actual experience conforms to prior expectations. And unlike investment bank alternatives that utilize mark-to-model, LRS’s solution does not have the associated mark-to-model issues.
Counterparty Risk
The
approaches taken by LRS in addressing counterparty risk involves working with A
rated “fronted” risk-taking capacity that provide strong counterparty
worthiness or utilizing collateral or funded transactions. In addition to addressing counterparty credit risk, this approach enables the protection buyer to better manage counterparty concentration risk.
