Description of impact
Pension funds, life insurers and regulators are concerned about the financial consequences of longevity risk: the financial risk that, in aggregate, people live longer than anticipated. Novel stochastic models for the assessment of longevity risk (the Cairns-Blake-Dowd – CBD – family) in life insurance and pensions proposed by Cairns and co-authors in two landmark papers have been adopted by insurers in the UK, France and the US, actuarial consultancies in the UK and Germany, UK and European insurance regulators, specialist software providers, and in professional education.The CBD models have played a central role in the transfer of GBP10’s of billions of pension liabilities from pension funds to multinational insurers including the GBP16,000,000,000 transfer of BT pension liabilities in 2014. Use of the models provides an improved assessment of the financial consequences of longevity risk. This has enhanced the security of both pension funds and insurers and, through good risk management and regulation, has reduced the risk of insolvency.
Who is affected
The UK, France and the US, actuarial consultancies in the UK and Germany, UK and European insurance regulators, specialist software providers, and in professional education.Narrative
CBD models have been used to assess the potential impact of longevity risk on the future solvency of insurance companies writing annuities and pension funds in the UK, Europe and the US. Use of the models helps these institutions to:(a) assess more accurately their capital requirements (including regulatory) to ensure a secure future for policyholders, and
(b) price more accurately longevity risk transfers between institutions. In turn, this provides policyholders and pensioners with greater confidence that their promised benefits will be covered for the next 30, 40, 50 years. Members of the CBD family are often referred to by practitioners by their “M” numbers, e.g. M5, M7.
Software
Growing interest in the CBD family from insurance companies led the specialist actuarial software provider Longevitas to incorporate the CBD family into its Projections Toolkit. This software is used by UK and US insurers and its embedded suite of models facilitates insurance company compliance with the UK’s Prudential Regulatory Authority (PRA) guidance on the use of stochastic mortality models.
Other stakeholders, including the consultancy NMG and the European insurance regulator EIOPA, made use of an open-source R stochastic mortality modelling package, StMoMo, first released in 2015 that builds on. A significant proportion of StMoMo is devoted to the CBD family.
Regulation of European Insurers
Insurers in the EU have, since 2016, been subject to the Solvency II regulatory environment.
This governs how much capital insurers are required to hold to cover their future uncertain liabilities. Required capital consists of the market consistent value (MCV) plus the Solvency Capital Requirement (SCR). The SCR is an additional amount over the MCV to cover the risk that, alongside other risks, mortality rates fall at a faster rate than anticipated. The SCR can be calculated using a simple stress test or through use of a stochastic internal model. Larger insurers often prefer to use the latter, as these allow for a more accurate, company-specific analysis of all major risks.
Two distinct but related regulatory impacts can be identified:
1. For insurers using stochastic internal models, the UK’s Prudential Regulatory Authority (PRA) recommends use of the CBD family alongside three other families of model (with the use of distinct families to address model risk) to assess capital requirements for longevity risk. Out of these families, consultancy Barnett Waddingham recommends CBDM9 as being one of only two models suitable for a wide age range.
2. For insurers using the simpler longevity stress test, the CBD model was used by the EU insurance regulator, EIOPA, alongside one other model, to verify the suitability of the 20% longevity stress using the StMoMo software package. Responses to the EIOPA consultation (including institutions in the Netherlands, France and Ireland and pan-European professional bodies) indicate that the CBD model is in widespread use around Europe.
The PRA approach to the assessment of model risk and the range of models employed reflects the influence of Cairns et al. (2009). As a result of the PRA guidance, CBD models and the model-risk framework of Cairns et al. (2009) are widely used by insurers in the UK and elsewhere. Quoting UK and EU insurers, “was cited in the governance of our [Aviva’s] Solvency II internal model and helped to mould our approach to the assessment of longevity risk.”, and “has impacted significantly on our work in three ways: their proposal of a number of new and innovative stochastic mortality models; their finding that model risk can be quite significant; and their approach to model selection using multiple criteria”.
Derisking of Defined Benefit (DB) Pension Funds
Many DB pension funds are seeking to reduce their exposure to longevity and investment risks.
Derisking is often achieved, in part, through longevity hedges such as longevity swaps and bulk buy-outs with insurers in the UK or overseas. Insurers receiving the risk from pension funds use CBD models:
(a) to assess a best estimate price,
(b) to assess the degree of longevity risk embedded within each portfolio of pensions and then
(c) to determine a risk premium to be charged for acceptance of the risk. UK insurers taking on such risks are then subject to the Solvency II regulations discussed above.
Longevity Risk Transfers
There has been “approximately $200 billion [USD] of longevity risk transfer since 2014”. Kessler of Prudential Insurance Corporation of America (PICA) states “Over the period 2014-2017, we used the CBD models for pricing all of our global transactions, covering a total transfer of liabilities of approximately $40 billion [USD]. This included the largest longevity transaction to date, covering £16 billion [GBP] of pension liabilities in the BT pension scheme in 2014. … The use of the CBD models was central in establishing confidence in the pricing of all of these transactions.”
Actuarial Consultancies
CBD models and their descendants are used by actuarial consultancies in the UK and elsewhere in their advisory and development work. Kaufhold states that (see document attached) is the go-to, fundamental reference that has brought order and rigour to what had, at times, been a somewhat naïve longevity risk-transfer market. Also states that and e.g. are fundamental works in helping his firm and clients understand and model socio-economic mortality differentials.
Professional Education
Recognising the role of CBD models and model risk in longevity risk management, the German Actuarial Association (DAV) recommends as part of the DAV’s reading for its Chartered Enterprise Risk Actuary qualification (CERA).
Please check the attached document
| Impact status | Achieved |
|---|---|
| Impact date | 1 Jan 2014 → 31 Dec 2020 |
| Category of impact | Economic |
| Impact level | International |
Keywords
- 2021