RBC Capital analysts believe an estimated record seven-month reduction in life expectancy will significantly boost profits at insurers Aviva PLC (LSE:AV.), Just Group PLC (LSE:JUST), Legal & General Group PLC (LSE:LGEN ), M&G PLC (LSE:MNG) and Phoenix Group Holdings PLC (LSE:PHNX), which is not yet part of the consensus forecast.
On October 11, 2022, the Institute of Actuaries (IofA) gave a first indication that the high level of excess deaths this year could lead to the record seven-month reduction in life expectancy. The CMI – a body within the IofA – saw its third quarter 2022 mortality monitor confirm a significant increase in death rates seen in England and Wales during the quarter, and importantly also looked towards the potential outcome of life expectancy projections.
Analysts noted that the average annual reduction in life expectancy over the past five years has been just 1.8 months. However, a still open question is whether the CMI will apply full weighting to the prevailing 2022 data, or omit it, as it did in 2020 and 2021.
They pointed out that mortality since the start of 2022 was 4% higher than in 2019 – the last year for which the CMI model did not ignore death data – the third quarter in particular having recorded a high number of deaths. Although COVID-19 accounted for 60% of the higher mortality between the third quarter of 2019 and the third quarter of 2022, the third quarter was the first quarter of this year where there are also more non-COVID-related deaths. 19 than expected. Data from the Office for Health Improvement also suggests that heart and circulatory disease have contributed to the high level of mortality recorded – with cancer deaths similar to pre-pandemic levels.
Analysts noted that the CMI provides sensitivities for 2022 life expectancy for a given change in mortality during the year. The application of the higher than expected year-to-date mortality improvement rate (-2.6% compared to 2019) and the adjustment to the initial data of the 2021 census – what the CMI has previously stated that it would – leads to a reduction in life expectancy of 2.6% or seven months for a 65-year-old man.
Analysts said this was significantly higher than the life expectancy reductions of recent CMI models, analysts said. Basically, this reduction in life expectancy assumes a 100% weighting for 2022 data, however, it is uncertain whether the CMI will take this approach after stating that it will “continue to monitor mortality during the remaining portion of 2022 to inform choice of method and for the next version of the CMI Mortality Projections Model, including the weight of 2022 data…by the end of 2022.”
If a 0% weighting is used in the 2022 CMI model, it will result in about a month’s reduction in future life expectancy, analysts noted, and assuming insurers adopt a new version of the CMI model each year, bank-wide. coverage, based on the model used for the 2021 annual results, they forecast a transition to the CMI 2022 model in 2023 for Phoenix Life and in 2024 for Aviva, L&G, M&G and Just Group.
Exposure of insurers to longevity risk
Through their annuity portfolios, which are on average 6.0 times larger than their market capitalisations, insurers are exposed to longevity risk. This has been a tailwind in recent years as reserve releases can be reinvested in new annuity business, returned to shareholders via special dividends or retained as excess capital, analysts noted.
For defined benefit pension schemes in the UK, longevity swaps/hedges are less prevalent compared to insurers’ annuity portfolios, and analysts therefore expect a relatively larger benefit to sector liabilities compared to relation to insurers. This will reduce funding shortfalls and shorten the plans’ paths to their end goals – which they say will be redemptions for 60% of plans – supporting wholesale annuity volumes.
Analysts have concluded that the longevity reserve releases will be large, equivalent to 15% of the sector’s market capitalization, and – in their view – not currently reflected in the earnings consensus.
Although they did not specifically update the forecast for the seven-month reduction in life expectancy in the 2022 CMI, RBC analysts concluded that it is directionally consistent (although d greater magnitude) with their current forecasts.