Mandeep Jagpal, RBC Capital Markets’ Equity Financials Analyst, discusses his recent study into key factors affecting UK life expectancy. His research, which includes the impacts of COVID and continuation of higher dementia related deaths, suggests that UK life insurers have been overly optimistic in forecasting future improvements in life expectancy and will therefore see higher profitability in the future.

Insurance: What's happening with UK life expectancy? | RBCCM

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Today, I'm joined by Mandeep Jagpal,

who sits within our European Insurance Team.

And he's got a background, before joining us,

as a pensions and investment actuary.

A lot of Mandeep's research

has a particular focus on the emerging themes

in the UK life insurance sector.

And one of the themes he's done a lot of work on

is projections of the future life expectancy and longevity.

And this is a topic of high interest for both life insurers

as well as, I'm sure, the wider population.

And it's also the topic of today's podcast.

So Mandeep, welcome to the podcast.

- Hi Mike. Thank you.

- So, as I said, today's topic is about

future life expectancy and longevity

an area where we've got a differentiated view

as RBC versus the market.

It's quite a complex topic.

I'd love you to give us an overview

of why life expectancy trends are important

to the UK life insurance sector

and where actually RBC's views are different to the market.

- Thanks Mike, at the high level overview,

based on our analysis

of the factors affecting life expectancy

and the most recent mortality data

we think that insurers have been overly optimistic

in forecasting future improvements in life expectancy.

However, market earnings consensus does not yet factor

this potential upside into its estimates

as it has not yet fully adjusted for the long term impact

of COVID or the increasing rates of dementia

on life expectancy.

In our research, we undertake a forward looking approach

to forecasting the drivers of longevity

rather than just relying on the historic data.

As a result of this analysis

we think that longevity benefits will be material,

equating to 14% of the sector's market cap

over the next five to six years.

- Okay, that's interesting.

When you talk about improving longevity

it's actually people dying earlier than forecast.

- That's right.

So when I say improving longevity,

I refer to future life expectancy improvements

and how these improvements aren't going to be as high

as they were previously expected.

So, unfortunately people will be dying,

although living longer than they currently are,

they'll be dying sooner than they

previously thought. - Gotcha, understood.

So then, before getting into your thesis then

could you explain how life insurers are exposed

to that changing life expectancy?

- Yeah, so I'll start at the beginning.

When writing a new policy the actuaries

within these insurers make assumptions

around how long they expect the policy holder to live for

and this ensures that they charge the appropriate premium.

However, over time, due to various factors

which we'll touch on later, these forecast life expectancies

have actually been coming down over recent years.

Intuitively many people may think

that policyholders living less long

is bad for life insurers as they need to pay out more

sooner than they expected on these life insurance policies.

However, we think that this is a misconception

as in the UK it's annuity policies,

rather than life insurance policies

which make up the majority

of the business of these insurers.

- Got you.

- Annuities pay policy holders a guaranteed income

for their entire life and therefore open up insurers

to something called longevity risk.

Big question is, given the COVID related shock to mortality

what will be the trend going forward?

Our new research, which draws on the opinions

from demographic experts

and the most recent mortality data

points to current life expectancy projections

that are being used by insurers, still being too high.

And we think that these life expectancy projections

will need to come down further in the future.

So putting all that together,

our view is that historically,

the premiums charged by insurers

based on the data available at that time

will end up being too prudent

and that these insurers will be able to release

this additional capital back to shareholders

resulting in higher profits and improved capital positions.

- Understood, so UK life insurers have the most exposure

to life expectancy changes through the annuity policies

that they write and that opens them up to longevity risk.

Before we get on to why you think longevity risk

will be a positive driver going forward

maybe you could explain what the trend has been historically

and how material this has been to the sector historically?

- Yeah, sure.

So annual improvement in UK longevity have been consistent

for a number of decades until 2011.

This was helped by a stable reduction each year

in heart disease related deaths

as the prevalence of smoking reduced.

However, since 2011, the benefit to longevity

from people quitting smoking has leveled off

as the number of people quitting each year has reduced

as a smaller amount of the population's left who smokes.

Alongside the fewer people now quitting smoking

has also been a notable increase in deaths from dementia.

These factors have led to a clear slowdown

in recent annual longevity improvements

and for the UK life insurance sector,

this has resulted in longevity reserve releases

being a material driver of earnings.

Over the last five years longevity releases

have accounted for 20% of operating profits.

- Okay, so looking forward,

you mentioned in your opening remarks and comments there

that you think COVID and dementia will be factors

driving life expectancy reductions versus forecast

going forward.

What's the impact of these factors and why,

if you can see it, hasn't the industry

or the market really recognized them?

- Yeah, so insurer's have a traditionally

updated the longevity forecast annually

and this is where they adopt the most recent version

of the Institute of Actuaries Longevity Improvement Model,

and this reflects the most recent years mortality data.

However, since the onset of COVID,

the significant increase in the number of deaths

has meant that data from 2020 and 2021

has been unsuitable for use in these models.

And so insurers have chosen to ignore

all the prevailing data since 2019 in their forecast.

This means that due to this one of shock,

insurers have not yet taken into account

any of the underlying trends in longevity

for the last two years

and then therefore completely ignore

the long term impacts of COVID

as well as the continuation of pre COVID trends,

such as higher dementia related deaths.

So rather than waiting for this data to emerge

over the next few years,

in our research we have attempted to analyze

underlying trends and forecast

the size of potential longevity profits

for the next few years, which we think will be significant.

- Okay, so moving on to the drivers themselves then,

how will COVID impact your forecast?

- Yeah, so there's growing consensus and recognition

that unfortunately COVID will have a negative impact

on longevity improvements.

And some of this potential evidence

has already started to be revealed

with higher than expected deaths in the UK

over the last few months

as social restrictions have been removed

and lifestyles have normalized.

Additionally, the second order effects of the pandemic

are likely to have much wider ranging impacts

on life expectancy

and these may not be initially obvious.

For example, firstly, there's been an increase

in NHS waiting times across the country

due to initially, the COVID response

but these are yet to recover to pre pandemic levels.

For instance, now only 71% of cancer patients

are seen within six weeks of a diagnostic test,

down from 97% before the pandemic.

Secondly, the knock on effects of factors such as

funding for the health and social care system

whether it be mental health or emergency care

is likely to have a noticeable impact

on how life expectancy improves

as we have seen in previous recessions.

But it's not just broader implications of the pandemic

on how we deliver healthcare

that we expect to be a driver of longevity going forward.

Another key factor is dementia,

which is actually one of the few diseases

that has been getting worse in recent years

as the population has aged.

Since 2011 dementia has been the number one cause of death

for females in the UK, surpassing heart disease and strokes.

Many of these diseases can be influenced

by advertising regulation and taxes,

but the causes and cures of dementia are much less obvious.

So when insurers finally start updating

their longevity assumptions for these underlying factors,

which we think will be from 2024,

we expect it will trigger

material longevity reserve releases.

- Okay, so it's quite a gloomy picture you paint,

COVID, dementia, but also how we are delivering healthcare

post the pandemic and the implications of that.

You said there that you're not expecting insurers

to actually start reflecting this assumptions until 2024

what's gonna happen until then

and how's that gonna appear in the market?

- Yeah, so there's a number of factors

that will drive higher mortality rates

over the shorter term as well.

And these include the return of the flu

and the cost of living crisis.

Flu levels have been extremely depressed

for the last few years

but as social distancing measures have now been relaxed

we expect flu related deaths to come back

although not to the same extent as pre 2020.

And this is due to endemic COVID cases

also being around now.

The data from Australia supports this thesis

as flu deaths have surged again in recent months

after being dormant for the last two years.

Now, in terms of less direct impacts on life expectancy,

the cost of living crisis represents a real challenge

in particular with soaring energy prices,

it will cost people a lot more to heat their homes

and historically 30% of excess deaths in winter

are caused by people living in a cold home

according to World Health Organization Estimates.

So in summary, it's flu, endemic COVID

and the cost of living crisis

that may cause excess mortality in the short term

and this will generate some small reserve releases

over the next few years.

While reserve releases and profits will really ramp up

over the medium to longer term

when the insurers have the data that they need

to show this underlying negative impacts of COVID

and dementia and so allow the insurers

to finally update their forecast.

- Okay, Mandeep, it's quite a gloomy picture you paint

in terms of mortality rates

and actually life expectancy being lower than anticipated.

But I guess for your companies, the life insurers

it actually reflects a better picture,

a chance to reverse some of the provisions.

Let's see how this develops over coming years

and how it plays through.

Really interesting insights, let's stay in touch on it.

Thanks very much.

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