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Pension funds and annuity providers should look to adapt their benefit structure or product offering to different segments of society as an alternative solution to managing their exposure to longevity risk, OECD said. It made the comments in its 2016 Business and Finance Outlook. The report focussed on the “fragmentation” in a variety of areas of life, including in financial markets, regulatory and legal regimes, and life expectancy.
The OECD has previously called for the development of capital markets solutions for longevity risk and in its latest report said that the “capital markets could potentially offer additional capacity at a lower cost”. However, it went on to note that there are problems with the index-based longevity instruments that are needed to meet capital market investors’ need for transparency and flexibility.
Asked whether the OECD was giving up on or at least backing away from the idea of capital markets solutions fo rmanaging longevity risk, Pablo Antolín-Nicolás, principal economist and head of the private pensions unit at the OECD, said it was not. “We still believe that market solutions are part of the overall solution to manage longevity risk,” he said. ”We are just highlighting that socio-economic differences in mortality trends creates additional problems to develop market solution for managing longevity risk.”
According to the OECD, index-based hedging instruments have drawbacks because they do not provide a full transfer of the risk, which leaves pension funds or annuity providers with what is referred to as a basis risk – the potential shortfall between payments from a swap counterparty and payments owned to annuitants.
Divergence in mortality improvements means that “the magnitude of this basis risk can be significant, reducing the effectiveness of the longevity swap to hedge the longevity risk of the pensioners or annuitants”, said the policy organisation. The OECD noted that very few index-based longevity hedges have been executed.
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