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A COMPARATIVE STUDY OF TWO-POPULATION MODELS FOR THE ASSESSMENT OF BASIS RISK IN LONGEVITY HEDGES

Published online by Cambridge University Press:  29 August 2017

Andrés M. Villegas ,
Steven Haberman ,
Vladimir K. Kaishev  and
Pietro Millossovich
Andrés M. Villegas
Affiliation:
School of Risk and Actuarial Studies and ARC Centre of Excellence in Population Ageing Research (CEPAR), UNSW Business School, University of New South Wales, Sydney, Australia, E-Mail: a.villegas@unsw.edu.au
Steven Haberman
Affiliation:
Cass Business School, Faculty of Actuarial Science and Insurance, City, University of London, London, UK, E-Mail: s.haberman@city.ac.uk
Vladimir K. Kaishev
Affiliation:
Cass Business School, Faculty of Actuarial Science and Insurance, City, University of London, London, UK, E-Mail: v.kaishev@city.ac.uk
Pietro Millossovich*
Affiliation:
Cass Business School, Faculty of Actuarial Science and Insurance, City, University of London, London, UK Department of Economics, Business Mathematics and Statistics ‘B. de Finetti’, University of Trieste, Italy
*
E-Mail: Pietro.Millossovich.1@city.ac.uk
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Abstract

Longevity swaps have been one of the major success stories of pension scheme de-risking in recent years. However, with some few exceptions, all of the transactions to date have been bespoke longevity swaps based upon the mortality experience of a portfolio of named lives. In order for this market to start to meet its true potential, solutions will ultimately be needed that provide protection for all types of members, are cost effective for large and smaller schemes, are tradable, and enable access to the wider capital markets. Index-based solutions have the potential to meet this need; however, concerns remain with these solutions. In particular, the basis risk emerging from the potential mismatch between the underlying forces of mortality for the index reference portfolio and the pension fund/annuity book being hedged is the principal issue that has, to date, prevented many schemes progressing their consideration of index-based solutions. Two-population stochastic mortality models offer an alternative to overcome this obstacle as they allow market participants to compare and project the mortality experience for the reference and target populations and thus assess the amount of demographic basis risk involved in an index-based longevity hedge. In this paper, we systematically assess the suitability of several multi-population stochastic mortality models for assessing basis risks and provide guidelines on how to use these models in practical situations paying particular attention to the data requirements for the appropriate calibration and forecasting of such models.

Keywords

Stochastic moralitylongevity basis risktwo-population mortality modelshedge effectivenessindex-based hedges

Information

Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 47 , Issue 3 , September 2017 , pp. 631 - 679
Copyright
Copyright © Astin Bulletin 2017 

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