Derivatives houses looking to kick-start a market for instruments linked to mortality, such as swaps in which investors pay or receive a death rate, have failed to find favor with investors. A longevity bond, in which the coupon on the bond falls as the death rate of U.K. resident men who were 65-years old in 2003 increases, announced by the European Investment Bank and BNP Paribas in November has not yet launched because it has not attracted investors. Derivatives dealers have in the past attempted to create mortality risk structures through securitization (DW, 12/17/01).
Denis Autier, global head of risk solutions at BNP Paribas in London, said the bank hopes to issue the bond as soon as possible, but he noted it is a question of the whole pension fund community getting familiar with the product. Funds have to talk to consultants and their trustees and this process takes time, he added. One pension fund sales official agreed funds take a long time to buy into new products. Interest rate and inflation risk are much higher up the agenda for funds, but they were still slow to get into these markets, he added.
David Clark, head of funding at the European Investment Bank in Luxembourg, said it is still working with several counterparties on mortality-linked instruments and is talking to a range of investors including insurance companies as well as pension funds. Clark said a key question these investors ask is, What are the regulatory benefits? Because it is such a new product, this is not always clear, he explained. One official said insurance companies are put off by the product because they may have to put up more regulatory capital to hold it, which makes it less appealing than gilts.
Dawid Konotey-Ahulu, managing director and head of the pension fund group for Europe at Merrill Lynch in London, said while there are innovative products out there, most pension funds do not have a mandate to buy enough of these products to materially reduce risk and if they have concerns over liquidity and determining transparent market levels for pricing, then they may think twice about investing in these instruments just yet. "It's a bit like Betamax," said Konotey-Ahulu, adding, "There are early prototypes out there, but they tend to be expensive for what they achieve--we don't yet have the DVD." Officials agree there will eventually be a two-way market for longevity bonds and swaps but until fundamental issues for trustees are addressed such as cost, basis risk, liquidity and transparency, there's unlikely to be a stampede.
