CAIA - CIT 7 - Longevity Risk Transfer Markets

Question 1

___ ___ refers to the risk of paying pensions and annuities longer than expected.

Answer 1

Longevity risk refers to the risk of paying pensions and annuities longer than expected.

Question 2

There are 4 main longevity risk transactions:

1. B
2. B
3. L
4. L

Answer 2

There are 4 main longevity risk transactions:

1. buy-ins

2. buy-outs

3. longevity swaps

4. longevity bonds

Question 3

Insurers tend to use ___-___, ___-___and ___ ___for reducing longevity risk, whereas investment banks and re-insurers are associated with ___ ___.

Answer 3

Insurers tend to use buy-ins, buy-outs and longevity insurance for reducing longevity risk, whereas investment banks and re-insurers are associated with longevity swaps.

Question 4

A ___-___transaction is one where a plan’s assets and liabilities are transferred to an insurer for an up-front premium.

Answer 4

A buy-out transaction is one where a plan’s assets and liabilities are transferred to an insurer for an up-front premium.

Question 5

With a buy-out transaction, pensioners become exposed to the risk of ___ ___.

Answer 5

With a buy-out transaction, pensioners become exposed to the risk of insurer failure.

Question 6

With a ___-___transaction, a pension plan retains its assets and liabilities, and pays an up-front premium to an insurer in exchange for periodic payments that match the pension payments.

Answer 6

With a buy-in transaction, a pension plan retains its assets and liabilities, and pays an up-front premium to an insurer in exchange for periodic payments that match the pension payments.

Question 7

Buy-outs and buy-ins are usually (expensive/inexpensive).

Answer 7

Buy-outs and buy-ins are usually expensive.

Question 8

A ___ ___is one in which the pension plan makes periodic fixed payments to the swap counterparty in exchange for periodic payments based on the difference between the actual and expected pension or annuity mortality payments.

Answer 8

A longevity swap is one in which the pension plan makes periodic fixed payments to the swap counterparty in exchange for periodic payments based on the difference between the actual and expected pension or annuity mortality payments.

Question 9

As opposed to buy-outs and buy-ins, longevity swaps transfer only the ___ risk and not the ___risk.

Answer 9

As opposed to buy-outs and buy-ins, longevity swaps transfer only the longevity risk and not the investment risk.

Question 10

An advantage of ___ and ___-___is that they can be used to hedge the longevity risk of a specific section of the underlying population.

Answer 10

An advantage of swaps and buy-ins is that they can be used to hedge the longevity risk of a specific section of the underlying population.

Question 11

___-___remain the most used transaction in the UK for reducing longevity risk.

Answer 11

Buy-outs remain the most used transaction in the UK for reducing longevity risk.

Question 12

Most of the large UK LRT transactions since 2007 have been ___-___or ___ ___, and all of the recent large LRT transactions in the U.S. have been ___-___.

Answer 12

Most of the large UK LRT transactions since 2007 have been buy-ins or longevity swaps, and all of the recent large LRT transactions in the U.S. have been buy-outs.

Question 13

___ ___are currently conceptual instruments and have not been successfully used.

Answer 13

Longevity bonds are currently conceptual instruments and have not been successfully used.

Question 14

Smaller pension funds have a ___ incentive to transfer longevity risk.

Answer 14

Smaller pension funds have a stronger incentive to transfer longevity risk.

Question 15

Europe’s ___ will introduce capital requirement for longevity risk that will allow for risk-mitigation techniques under certain circumstances.

Answer 15

Europe’s Solvency II will introduce capital requirement for longevity risk that will allow for risk-mitigation techniques under certain circumstances.

Question 16

The conditions which will provide regulatory relief under Solvency II are:

1. LRT buyer shows arrangement doesn’t result in ___ ___
2. Instrument does not involve ___ ___ ___

Answer 16

The conditions which will provide regulatory relief under Solvency II are:

1. LRT buyer shows arrangement doesn’t result in new risks
2. Instrument does not involve material basis risk

Question 17

Longevity risk has ___ or ___correlation with other risks held by insurers and other buyers of LTR.

Answer 17

Longevity risk has low or negative correlation with other risks held by insurers and other buyers of LTR.

Question 18

Potential new buyers of longevity risk are ___ ___, ___ ___ ___, and ___ ___.

Answer 18

Potential new buyers of longevity risk are asset managers, sovereign wealth funds, and hedge funds.

Question 19

A ___ ___involves a lender advancing cash to a borrower in the form of an up-front lump sum or periodic annuity like payments. It accrues interest and is settled upon sale of the property.

Answer 19

A reverse mortgage involves a lender advancing cash to a borrower in the form of an up-front lump sum or periodic annuity like payments. It accrues interest and is settled upon sale of the property.

Question 20

A reverse mortgage is a ___-___loan.

Answer 20

A reverse mortgage is a non-recourse loan.

Question 21

A ___-___loan is one where the lender cannot seize the borrower’s assets beyond the collateral to cover shortfall.

Answer 21

A non-recourse loan is one where the lender cannot seize the borrower’s assets beyond the collateralto cover shortfall.

Question 22

A reverse mortgage lender faces 3 key risks:

1. L
2. P
3. R

Answer 22

A reverse mortgage lender faces 3 key risks:

1. Longevity

2. Property depreciation

3. Rising interest rates

Question 23

In most countries, reverse mortgages on bank balance sheets are treated (the same as/different from) other residential mortgages.

Answer 23

In most countries, reverse mortgages on bank balance sheets are treated the same as other residential mortgages.

Question 24

Impediments to growth of the LRT market are:

1. A
2. B
3. R

Answer 24

Impediments to growth of the LRT market are:

1. Asymmetric information

2. Basis risk

3. Regulation

Question 25

When pension funds have more information about the health and longevity risk of their pension holders, buyers of longevity risk are exposed to ___ ___.

Answer 25

When pension funds have more information about the health and longevity risk of their pension holders, buyers of longevity risk are exposed to lemons risk.

Question 26

___ ___is the financial risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other.

Answer 26

Basis risk is the financial risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other.

Question 27

Basing transactions on standardized population cohorts improves ___, but may expose sellers to ___risk. ___methodologies have been proposed to reduce this risk, but they have not been widely accepted and credit rating agencies will only give partial credit for ___-based transfer structures.

Answer 27

Basing transactions on standardized population cohorts improves liquidity, but may expose sellers to basis risk. Index methodologies have been proposed to reduce this risk, but they have not been widely accepted and credit rating agencies will only give partial credit for index-based transfer structures.

Question 28

The use of out-of-date ___ ___ and ___ ___ ___ may explain the lack of a growing LRT market.

Answer 28

The use of out-of-date mortality projections and higher discount rates may explain the lack of a growing LRT market.

Question 29

____ in ____ will impose a longevity risk charge on insurers plus a risk margin. A formula based “___ ___ ___ “ is set to ensure that insurers can meet their obligations.

Answer 29

Solvency II in Europe will impose a longevity risk charge on insurers plus a risk margin. A formula based “solvency capital requirement” is set to ensure that insurers can meet their obligations.

Question 30

U.S. DOL ___ No. ___ sets a “___ ___ ___” standard that some contend has restricted pension de-risking.

Answer 30

U.S. DOL Bulletin No. 95-1 sets a “safest available annuity” standard that some contend has restricted pension de-risking.

Question 31

Which of the following create counterparty risk?

1. Buy-ins
2. Buy-outs
3. Longevity swaps
4. Longevity Insurance
5. Longevity Bonds

Answer 31

Which of the following create counterparty risk?

1. Buy-ins

2. Buy-outs (does not create counterparty risk)

3. Longevity swaps

4. Longevity Insurance

5. Longevity Bonds

Question 32

Buy-ins have ___ counterparty risk than insurance transactions.

Answer 32

Buy-ins have greater counterparty risk than insurance transactions.

Question 33

___ and using ___ ___are helpful in addressing counterparty default risk.

Answer 33

Diversification and using credit ratings are helpful in addressing counterparty default risk.

Question 34

The primary risks of LRT are:

1. B
2. R
3. O
4. D
5. C

Answer 34

The primary risks of LRT are:

1. Basis risk

2. Rollover risk

3. Opacity risk

4. Diversification/risk management

5. Counterparty risk

Question 35

___ ___occurs when the longevity hedge is imperfect.

Answer 35

Basis risk occurs when the longevity hedge is imperfect.

Question 36

Since longevity swaps tend to mature before closure of the underlying pension plan, the plan is exposed to ___ ___.

Answer 36

Since longevity swaps tend to mature before closure of the underlying pension plan, the plan is exposed to rollover risk.

Question 37

LRT may result in ___ ___due to differences in knowledge and expertise of the longevity risk buyer and seller.

Answer 37

LRT may result in opacity risk due to differences in knowledge and expertise of the longevity risk buyer and seller.

Question 38

If increased longevity is ___, then all contracts will become “___ ___ ___” and cause the LRT market to collapse.

Answer 38

If increased longevity is systemic, then all contracts will become “in the money” and cause the LRT market to collapse.

Question 39

Supervisors should communicate and cooperate on LRT internationally and cross-sectorally to reduce potential ___ ___.

Answer 39

Supervisors should communicate and cooperate on LRT internationally and cross-sectorally to reduce potential regulatory arbitrage.