Longevity Risk and Natural Hedge Potential in Portfolios of Life Insurance Products: The Effect of Investment Risk

CentER Discussion Paper Series No. 2011-036

42 Pages Posted: 6 Apr 2011 Last revised: 30 Apr 2011

See all articles by Ralph Stevens

Ralph Stevens

CPB Netherlands Bureau of Economic Policy Analysis; CEPAR

Anja De Waegenaere

Tilburg University - Department of Econometrics & OR, Netspar, and CentER

Bertrand Melenberg

Tilburg University - Center for Economic Research (CentER)

Date Written: March 18, 2011

Abstract

Payments of life insurance products depend on the uncertain future evolution of survival probabilities. This uncertainty is referred to as longevity risk. Existing literature shows that the effect of longevity risk on single life annuities can be substantial, and that there exists a (natural) hedge potential from combining single life annuities with death benefits or from investing in survivor swaps. The effect of financial risk on these hedge effects is typically ignored. The aim of this paper is to quantify longevity risk in portfolios of mortality-linked assets and liabilities, taking into account the effect of financial risk. We find that investment risk significantly affects the impact of longevity risk in life insurance products. It also significantly affects the hedge potential that arises from combining life insurance products, or from investing in longevity-linked assets. For example, our results suggest that ignoring the effect of financial risk can lead to severe overestimation of the natural hedge potential from death benefits, and underestimation of the hedge effects of survivor swaps.

Keywords: Life insurance, life annuities, death benefits, survivor swaps, risk

JEL Classification: G22, G23

Suggested Citation

Stevens, Ralph and De Waegenaere, Anja M.B. and Melenberg, Bertrand, Longevity Risk and Natural Hedge Potential in Portfolios of Life Insurance Products: The Effect of Investment Risk (March 18, 2011). CentER Discussion Paper Series No. 2011-036. Available at SSRN: https://ssrn.com/abstract=1799325 or http://dx.doi.org/10.2139/ssrn.1799325

Ralph Stevens

CPB Netherlands Bureau of Economic Policy Analysis ( email )

P.O. Box 80510
2508 GM The Hague, 2585 JR
Netherlands

HOME PAGE: http://https://www.cpb.nl/medewerkers/ralph-stevens

CEPAR ( email )

Sydney, NSW 2052
Australia
+61 2 9385 1883 (Fax)

Anja M.B. De Waegenaere (Contact Author)

Tilburg University - Department of Econometrics & OR, Netspar, and CentER ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Bertrand Melenberg

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2730 (Phone)

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