Managing Longevity Risk

When we think about life insurance, we often focus on the policyholder's death. But what if life insurance companies have more to worry about than just untimely deaths? Increasing longevity is one of the primary challenges they now face. Life insurers have long relied on certain mortality assumptions, but in a world where people live longer than ever before, these assumptions no longer hold.

What Is Longevity Risk? - Longevity risk refers to the financial risk that arises when people live longer than expected, particularly in the context of insurance policies. The longer people live, the more money life insurers must pay out in benefits.

The Growing Longevity Trend - life expectancy worldwide has steadily increased over the past several decades. For example, in 2020, the average life expectancy was 78.8 years in USA, a significant jump from 69.7 years in 1950. This trend means that life insurers are now obligated to pay benefits for a longer period than originally predicted.

But it's not just life expectancy that's increasing. The number of people living well past 100 is also growing, creating an entirely new category of risk for insurers. The World Health Organization predicts that the number of people aged 100 years and older will increase tenfold by 2050.

The Solvency Dilemma - Solvency is a critical concept for any insurer, as it refers to the company's ability to meet its long-term obligations to policyholders. When life expectancy increases, insurers face a unique problem: they may not have enough capital reserved to pay for longer-than-expected lifespans.

Underestimating the Cost of Longevity - One of the things that stood out is the frequency of actuaries adjusting their mortality assumptions. During the initial stages of the company's operations, life expectancy models were based on data that didn’t factor in the recent improvements in healthcare, nutrition, and technology. Insurers were often caught off guard when a larger-than-expected number of policyholders reached their 90s or 100s. In hindsight, insurers realized that many long-term policies were not priced high enough to cover this risk.

Regulatory Implications - In addition to internal solvency concerns, life insurers must meet strict capital requirements set by regulators. According to the National Association of Insurance Commissioners (NAIC), insurers must hold reserves sufficient to cover expected payouts. With longevity risk increasing, insurers may need to boost their reserves, which could tie up capital that could otherwise be used for investment or business expansion.

Longevity Risk Management Strategies - While it’s clear that longevity risk poses a major solvency threat, insurers are developing strategies to mitigate this risk. Here are a few ways they're tackling the problem:

Adjusting Mortality Assumptions - Life insurers often rely on actuarial tables to predict the likelihood of policyholders reaching certain ages. By regularly adjusting these tables to account for rising life expectancies, insurers can better estimate their liabilities. According to the Society of Actuaries, updating these assumptions regularly is crucial for maintaining accurate risk assessments.

Diversification of Product Offerings - one of the most important strategies insurers implemented was diversifying its product portfolio. Insurers began offering products that addressed long-term care, critical illness, and annuity plans, which helped mitigate some of the risks associated with longevity. By offering products that span a range of lifespans, insurers can balance the higher risks of insuring elderly populations.

Reinsurance - Reinsuring part of the risk is another common strategy. Reinsurance allows insurers to share the financial risk of longevity with other companies. This not only helps with solvency but also reduces the impact of outlier events (e.g., a significant number of policyholders living exceptionally long lives). Reinsurance can be expensive, but it often offers an effective way to stabilize cash flow.

The Role of Technology in Longevity Risk - The role of data analytics and technology in managing longevity risk cannot be overstated. Advances in predictive modeling, artificial intelligence (AI), and big data have helped insurers better understand and forecast longevity trends.

Data and Predictive Analytics - By analyzing vast amounts of health data, insurers can predict lifespan with greater accuracy. For example, the University of Chicago recently released a study demonstrating how data-driven models could reduce the uncertainty associated with predicting life expectancy. The use of technology in underwriting and pricing life insurance is rapidly changing the landscape of the industry.

AI in Life Expectancy Predictions - AI algorithms have the ability to analyze patterns in data that would otherwise go unnoticed by traditional methods. For example, AI can identify genetic factors or environmental influences that may impact life expectancy. Insurers can use these insights to create more accurate, personalized insurance policies.

Balancing Longevity Risk and Profitability - So, what’s the solution to these challenges? How can life insurers manage longevity risk without compromising their financial stability? In my experience, sustainability and innovation are key. Insurers need to evolve with the times and adopt new technologies and risk management strategies that align with longer lifespans.

A Changing Mindset - While the increasing life expectancy may seem daunting, it’s important to note that life insurers can still thrive by adapting their business models. The key is forecasting future trends and preparing for long-term shifts in demographics. Companies that are proactive, rather than reactive, will continue to succeed in a rapidly changing environment.

Conclusion - Longevity risk solvency is a significant concern for life insurers in today’s world. As life expectancy rises, insurers must adjust their risk models and strategies to maintain financial stability. By updating mortality assumptions, diversifying product offerings, and embracing technology, insurers can mitigate the risks associated with longer life spans.