New research on the risks associated with longevity bonds could prompt their return to investment markets following a failed attempt a few years ago.

Macquarie University associate professor Jackie Li says theoretically sound and practically feasible approaches to managing longevity risk must be found.

“Longevity won’t go away, due to medical advances,” he told insuranceNEWS.com.au.

“All life insurers are facing this problem, and it has to be solved.”

Professor Li says insurers have three ways of solving their longevity risk, and the first is to use reinsurance. However, reinsurers do not like longevity risk either.

“Secondly, life companies can undertake natural hedging, by selling both life insurance and annuities. This is opposite businesses, so they hedge against each other and that will help the life insurer to survive.”

The third option is passing longevity risk to capital markets, and this has driven the university’s research, run by the Life & Longevity Markets Association and the Institute and Faculty of Actuaries in the UK.

Macquarie is supported by the University of Waterloo in Canada, the Australian National University and Mercer Australia.

Together they will develop an applicable methodology for quantifying the basis risk arising from the use of population-based mortality indices for managing longevity risk.

Professor Li says investment markets are hungry for new asset classes, and a properly researched longevity bond would be welcomed in the way catastrophe bonds were.

“Given a suitable premium, investors would be happy to price in the risks. But it is a complex investment vehicle, so there would need to be an education process.”

Professor Li says the research project aims to give insurers confidence to develop investment pools.

“You can’t have a perfect index, so you need to develop more sub-indices.

“We might see insurers with annuity portfolios, which are unique, creating a different index, and that is the basis of our project. We have a lot of work to do assessing the longevity risk using population-based mortality indices.”

Although the project’s timescale is one year, Professor Li says it will take longer to deliver a longevity bond to investment markets.

“The focus is on building up new models to calculate the risk, to enable a longevity bond to deliver a good return. The project will create a way to give investors more confidence in longevity bonds.”