Analysts at RBC Capital think that an estimated record seven-month reduction in life expectancy will significantly increase the earnings of 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 in consensus forecasts.
On 11 October 2022, the Institute of Actuaries (IofA) gave an initial indication that the high level of excess deaths this year could drive the record seven-month reduction in life expectancy. The CMI - a body within the IofA - saw its Q3 2022 mortality monitor confirm a significant increase in mortality rates observed in England and Wales over the quarter, and importantly also steered to the potential outcome for life expectancy projections.
The analysts noted that the average annual reduction in life expectancy over the last five years has been just 1.8 months. However, a question still outstanding is whether the CMI will apply a full weighting to the prevailing 2022 data, or omit it, as it did in 2020 and 2021.
They pointed out that mortality over the year-to-date 2022 has been 4% higher than 2019 - the last year for which the CMI model has not ignored death data - with Q3 in particular seeing a high number of deaths. Although COVID-19 accounted for 60% of the higher mortality between Q3 2019 and Q3 2022, Q3 was the first quarter this year where there also more non-COVID-19 deaths than expected. Data from the Office for Health Improvement also suggests that heart and circulatory diseases contributed to the high level of mortality experienced - with deaths from cancer similar to pre-pandemic levels.
The analysts noted that the CMI provides sensitivities for 2022 life expectancy for a given change in mortality over the year. Applying the higher-than-expected rate of mortality improvements in the year-to-date (-2.6% versus 2019) and adjusting for the initial 2021 census data - which the CMI has previously stated it would do - results in a life expectancy reduction of 2.6% or seven months for a male aged 65.
The analysts said this is materially above the life expectancy reductions from recent CMI models, the analysts said. Crucially, this reduction in life expectancy assumes a 100% weighting to 2022 data, however, it is uncertain whether the CMI will take this approach having stated it "will continue monitoring mortality during the remaining part of 2022 to inform the choice of method and for the next version of the CMI Mortality Projections Model, including the weight for 2022 data ... by the end of 2022."
If a 0% weighting is utilised in the CMI 2022 model, it will result in a circa one-month reduction in future life expectancy, the analysts noted, and assuming that insurers adopt a new version of the CMI model each year, across the bank's coverage, based on the model used for the full-year2021 results, they expect a move to the CMI 2022 model in 2023 for Phoenix Life and in 2024 for Aviva, L&G, M&G, and Just Group.
Insurers exposure to longevity risk
Through their annuity portfolios, which are on average 6.0 times larger than their market caps, insurers have exposure to longevity risk. This has been a significant 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, the analysts noted.
For UK Defined benefits pension schemes, longevity swaps/hedging is less prevalent relative to insurer annuity portfolios, and the analysts, therefore, expect a relatively larger benefit for the industry’s liabilities compared to insurers. This will act to reduce funding deficits, and shorten schemes’ journeys to their end-game targets - which they expect will be buy-outs for 60% of schemes - supporting bulk annuity volumes.
The analysts concluded that longevity reserve releases will be material, equating to 15% of the sector’s market cap, and - in their view - is not currently reflected in earnings consensus.
Although they have not specifically updated forecasts for the seven-month reduction in life expectancy in CMI 2022, the RBC analysts concluded that it is directionally consistent (although of a larger magnitude) with their current forecasts.