While there has been a general decline in faith-based worship in the western world, one would have thought that life companies’ faith in the core tenets of their business remained intact.
So what are we to make of the news that Aegon is hiving off risk, not to a re-insurer but to a bank? Aegon’s announcement that they have agreed a life expectancy swap deal with Deutsche Bank, covering €12 billion of their reserves can only be seen as a lack of confidence in the ability of the actuarial body to accurately forecast life expectancy. It does make you wonder where exactly the actuarial expertise now is seen to rest.
It also makes you wonder what levels of risk Deutsche Bank is prepared to take on. Their expertise in longevity is surely less than Aegon’s, so someone is going to take a bath on this one. However, Michael Amori, Deutsche’s co-head of the bank’s longevity group, was open about their lack of actuarial expertise. “This is not about the bank telling anyone what the right life expectancy is. It is about finding a way to help a client transfer risk to others willing to take the risk on in exchange for a return”.
Deutsche Bank will ultimately package these as risk products, and sell them on to other investors after taking a cut for their trouble. Those who buy from Deutsche may retain them or may repackage again and sell on, bringing back frightening memories of the triple A-rated Collateralized Debt Obligations (CDOs) that lay at the heart of the Lehman Brothers collapse.
Aside from the dangers to the economic system, if longevity risk ultimately starts getting rated and sold by non-experts in the area, each layer in this process will need to make a margin in order to justify the approach. And, at the base of this inverted pyramid it is the customer who is propping up the whole thing, from whose contributions all of the ‘margins’ required by those businesses ultimately have to come.
So what seems like a prudent move by Aegon in order to protect its future earnings could just be the start of a chain that actually destabilises everyone in it. In the end, only the customer will pay.
Of course, this whole process was inevitable from the moment Solvency II raised its head. Faced with the restrictions imposed by the need to increase their reserves to meet the new regulations arising from Solvency II, it was inevitable that Insurers would begin to look beyond traditional re-insurers in order to reduce their reserve requirements and allow better use of their capital for growth.
While a single deal, even of this size, is not worrying, Deutsche Bank is forecasting a big increase in the use of capital markets to hedge against longevity risk. This is a development that regulators will need to monitor closely.
If more and more life companies are losing faith in their own actuarial body, are we to be left placing our trust in the sagacity of the banks and market investors to get it right regarding the liabilities of the life and pensions sector?
Somehow we have to make sure that actuarial assessment remains to the forefront of risk management in the life business. Otherwise we may all end up with nothing to believe in.
What do you think? Is the insurance industry losing faith in their actuaries? Tell us what you think in the comments below!