To the uninitiated, the ‘Life Risk market’ is an umbrella term those in investment circles use to describe the transfer of mortality or longevity risk from the primary market to the capital markets. It manifests itself as two sides of the same coin; ‘mortality risk’ refers to the risk of loss arising from a population that experiences a shorter than expected lifespan whereas ‘longevity risk’ considers the opposite, i.e., risk of loss arising from a population that lives longer than expected. It’s a vast area of finance but one that has historically garnered relatively little attention as a coherent asset class, like commodities, real estate, or public equity.
Part of the reason why is a perceived lack of transactability.
“That’s definitely been a factor in the perception of this market,” said Douglas Anderson, Founder and Chief Visionary Officer of Club Vita. “And until recently it’s been a viewpoint that’s been difficult to argue against, as the rapidly growing needs for longevity risk transfer have been dominated by life reinsurers offering longevity swaps. In the late noughties, several investment banks were investing in developing alternative structures suitable for capital markets investors, but they lost their appetite after the global financial crisis. Since then, additional life insurers have entered the market, bringing new capacity and discouraging capital market investors from investing time and effort.”
Whilst the number of transactions in the life risk market – specifically, transactions where the ultimate bearers of risk are capital markets investors – has grown in recent years, another reason the phrase ‘life risk’ is not as commonplace in investment circles as its size would suggest is the siloed or bilateral nature of many life risk-based transactions. Even though there are a number of well-established secondary life markets, including the life settlement, structured settlement, and equity release (reverse mortgages in the US) markets – where there is a competitive and fluid bidding process – managers investing in these assets tend to be specialists with limited cross-domain capabilities.
“Investment managers in the life risk market don’t pitch their products in the same way as, say, a sector-focused public equity manager. Those firms tend to suggest their expertise complements an investor’s broader equity allocation,” said Philip Siller, Co-CEO and Founder of BroadRiver Asset Management. “Life risk investment opportunities serve a wider, cross-portfolio purpose, as a non-correlated diversifier and volatility reducer with high risk-adjusted returns. As such, they don’t have nearly as defined a bucket for investors. Life risk-based managers compete on their expertise of pricing life risk more effectively, and specifically identifying mispriced risk.”
Despite the perceptions – and the realities – about the life risk industry, it’s one that’s poised for significant, sustainable growth. In life settlements, for example, The American Council of Life Insurers Life Insurance Fact Book 2021 says that Americans purchased $3.3trn of new life insurance in 2020 to take the total life insurance coverage in the country to $20.4trn. The lapse rate of this insurance – where individual Americans simply cease paying for coverage – has been between 4-4.5% in terms of the number of policies in force each year for the last decade. Consequently, between $0.9trn and $1.0trn of insurance face value has been lapsed every year in the decade to 2020. While not all of this has intrinsic value in the eyes of the life settlement market, without doubt there is a vast amount of value Americans are just walking away from each year that could be sold in a secondary market.
Further, according to LIMRA’s 2020 Insurance Barometer Study, there was a ‘needs gap’ of 16% – i.e., 16% of Americans, or 41 million of them, who say they need life insurance but don’t have it. That’s a lot of primary market origination, some of which could eventually make its way to the secondary market. Other markets are similarly expecting future growth. The global mortgage equity release market is set to exceed $50bn by 2031 according to the Global Equity Release Roundtable 2020 survey report. Published by The European Pensions and Property Asset Release Group (EPPARG) and EY in January 2021, the report expects most of this growth to be driven by consumer demand, and the capital markets will need to be able to match this demand.
As we see more primary product origination, we will inevitably see more life risk transactions in secondary markets linked to longevity exposure of state-backed pension liabilities. Ageing populations in the West will push a higher percentage of the population into pensioner territory, and this demographic trend will provide an added need for capital market solutions in life risk.
“There is frequent media coverage about pension crises or inequality in mortality rate improvements in many countries,” said Anderson. “But we often don’t hear about solutions that can be provided by the financial markets. Life insurers – particularly the reinsurers specializing in biometric risk – have been the natural sellers of longevity hedging instruments, as it helps them to offset the mortality risk in their life insurance products. But now, as pension funds start to decommission en masse, the residual capacity on their balance sheets looks limited. Consequently, the playing field for capital markets investors is now levelling up.”
Whilst life risk in capital markets refers to the transfer of risk via secondary market transactions, many investors hold life risk in its more traditional sense. How many investors own stock in publicly listed life insurance companies, for example? According to Statista, the market capitalisation of just the top ten life insurance companies in February 2022 was $652.35bn. Many of these investors own public equity index ETFs – some of which hold life insurance companies in them. According to regulatory filings aggregator Docoh, passive investment behemoth Vanguard, across its myriad of products, held more than $3.5bn worth of stock in MetLife, a large originator of life insurance in the United States, in its most recent 13F filing. BlackRock held nearly $4.5bn worth of stock in the firm.
According to alternative investments data and analytics provider Preqin, the hedge fund industry managed some $4.3trn at the end of September 2021. The private equity industry managed $4.6trn, the private debt industry managed $1.2trn and the venture capital industry $2trn. These are all comparable to the life risk industry in the sense that they are vehicles that access a primary underlying market. Detailed figures aren’t available for the secondary life risk industry and it’s arguably impossible to put even a close-to-accurate figure on it given the siloed, opaque, nature of the market. But what if you could sum them all up? How big would this industry be?
“If you add together the capital markets participation in the various life risk-related silos that all ultimately have the same fundamental underlying exposure – life risk – then it’s not as big as some of these other sectors – yet” said Scott Willkomm, CEO at Life Equity. “But the primary markets are massive. You’re talking about potentially a multi-trillion-dollar industry.”
It’s unlikely that institutional investors consider life risk as an asset class in the sense that they carve out a part of their portfolio for this specific risk exposure. What is life risk, however, if not an asset class? The products in this industry have the same ultimate drivers of returns.
Life risk: the biggest investment industry you’ve never heard of that has the potential to get a whole lot bigger.
