Investors may be attracted to such bets because longevity trends aren't linked to movements in equities, bonds or commodity markets, said David Blake, director of the pensions institute at Cass Business School in London, who has worked with JPMorgan on the derivatives.
The complexity and risk involved in longevity assets with timelines of more than 20 years means banks are looking to create bonds that offer 5% to 9% in annual returns, according to Guy Coughlan, former head of longevity structuring at JPMorgan. Returns as high as the "mid-teens" are possible, he said.
'Structural Problems'
Investors remain unconvinced. Not knowing whether a bet on a group of pensioners' life spans is correct for decades prevents hedge funds such as London-based Leadenhall Capital Partners LLP from entering the marketplace.
"There are big structural problems with the longevity market," said Luca Albertini, CEO of Leadenhall, which has $120 million under management and invests in insurance-linked securities such as catastrophe bonds used to help cover hurricanes and other extreme risks. With clients able to withdraw investments only every month or quarter, "the only way I can invest is if the market is truly liquid," he said. "No one has proven that to me yet."
Subprime mortgages sold in the past decade were the genesis of the biggest financial meltdown since the Great Depression. Investment banks passed the risk of borrowers defaulting to the capital markets by packaging, or securitizing, the loans into bonds and selling them to investors and one another.
'Fully Collateralized'
Collateralized debt obligations were created and sold in such volume that when mortgage holders defaulted, governments in the U.S. and Europe had to bail out the financial system. Banks are now looking to investors in much the same way to securitize the risk of pensioners living longer than expected.
Securities based on life expectancy don't hold the same risks as those linked to subprime mortgages because they are "fully collateralized," minimizing the risk from a counterparty failing to meet its obligations, Coughlan said.
Cass Business School's Blake said it's unfair to compare the securitization of mortality expectations to the subprime- mortgage market.
"Subprime was highly leveraged," Blake said. "This is different."