Longevity-based investing has become a growing trend, fuelled by concerns about the risk of pension fund shortfalls and awareness that this area can generate steady returns.

Betting on when a person dies does not sound the most likely way to earn money or friends. Any market containing instruments dubbed “death derivatives” sounds downright nasty. But the market for trading in what is called longevity risk appears to be gaining ground.

Longevity risk, simply defined, is the chance of a person living longer than an actuary expects, leading to a shortfall of retirement cash. Some of the world’s pension funds are examining how to insure this risk and thereby avoid costly deficits, already a major corporate finance headache. Around £30 billion (around $46.8 billion) pounds of UK corporate pension liabilities have been insured (source: Bloomberg). Swiss Re has estimated that $17 trillion of the $23 trillion in pension-fund assets worldwide are exposed to longevity risk – and no wonder company bosses are sweating.

While industry groups in the UK and elsewhere collaborate to create markets for trading, insuring and hedging longevity risk, investment firms such as Centurion Fund Managers are touting their longevity-related portfolios so that wealthy private investors such as family offices, as well as big corporate or banking players, can tap returns.

For family offices and other wealth management institutions requiring a moderate, sustainable source of returns, longevity risk has its appeal as an asset class, CFM argues. (This business is part of Centurion Group, which has offices in London, Luxembourg, Mauritius and a representative office in Argentina).

“The family offices have got to understand the risks that they might be running in this market but they won’t want to employ the kind of in-house experts that an investment bank might do. But there is now enough transparency in this market to understand the risks,” David Rawson-Mackenzie, of Centurion, told WealthBriefing in a recent interview.

How it works

Longevity products essentially are an arbitrage between what an insurance company pays out on the death of a beneficiary and the costs that the customer pays until the beneficiary dies. A key issue is that the life expectancy of a person buying a policy on a specific date may change. Those variations are what give life insurance funds an opportunity to earn returns.

To date, tackling longevity risk has mainly involved investment banks producing bespoke products for large corporate pension schemes, rather than private investors, said Rawson-Mackenzie.

Recent examples include those of BMW, the German carmaker, and GlaxoSmithKline, the UK pharmaceuticals giant. Banks such as Deutsche Bank and JP Morgan, among others, are operating in this longevity space.

But for the smaller, private investor, the fund route is the more obvious channel. And that is where firms such as Centurion come in.

Returns

At Centurion, performance can be robust. For example, the Centurion Defined Return  Longevity Plus Fund, shows a 12-month performance to 15 April of 7.53 per cent (the fund is mark-to-model).

Meanwhile, there is also the Centurion Life Settlement Strategy Fund SPC (Managed Growth Class), launched as recently as June this year. It is also registered in the Cayman Islands. This is a mark-to-market product.

As more people enter the market, more data is collected about longevity and the industry, then liquidity improves, which aids price discovery and market efficiency, said Rawson-Mackenzie.

Mark-to-market pricing of life insurance assets has been an improvement on the previous, fixed approach that used a fixed discount rate. A mark-to-market valuation methodology values policies at current market price. It enhances liquidity by ensuring that returns incorporate the current market discount rate to more accurately reflect the asset values, he said.

Academic research

A leading researcher in this longevity risk field is David Blake, Professor of Pension Economics and Director of the Pensions Institute at Cass Business School in London. He has commented regularly on the need for the financial services industry to work out ways of handling longevity risk. The issue is likely to intensify: rising human lifespans, coupled with fiscal strains in many developed countries such as the UK, Italy and US, have put pressure on pension systems. More positively, advances in medicine and living standards have created the prospect that humans could out-live their ancestors by decades, a fact once confined to science fiction.

All kinds of financial firms are looking at the longevity risk space. The Xpect brand of Deutsche Börse, for example, produces data and indices supporting the market to trade and assess longevity, claiming to be a path-breaker in this field. (To view the Xpect products, click here). There are now longevity insurance policies, which are payments made if and only when a person hits a set age. Firms in this sector include US insurance giant MetLife, for example.

Another example of longevity-linked investment is in what are called life settlement funds. Based on US life policies, funds seek to buy policies sold by purchases ahead of their due maturity date, usually because a person, such as a terminally ill patient, wants the cash value early. The policies, which are sold at a discount, are held until their term expires. There has been some criticism about whether this market is properly understood.

The market in longevity may sound odd at first glance. But properly understood, it can also deliver useful returns as long as investors are prepared to stay in for the long haul.