Longevity Hedging 101: A Framework for Longevity Basis Risk Analysis and Hedge Effectiveness

North American Actuarial Journal, Volume 15, Number 2, 2011

38 Pages Posted: 10 Jul 2020

See all articles by Guy Coughlan

Guy Coughlan

Pacific Global Advisors

Marwa Khalaf-Allah

J.P. Morgan

Yijing Ye

affiliation not provided to SSRN

Sumit Kumar

Maharaja Agrasen Institute of Technology

Andrew J. G. Cairns

Heriot-Watt University - Department of Actuarial Science & Statistics

David P. Blake

City, University of London

Kevin Dowd

City University London - Sir John Cass Business School

Date Written: 2011

Abstract

Basis risk is an important consideration when hedging longevity risk with instruments based on longevity indices, since the longevity experience of the hedged exposure may differ from that of the index. As a result, any decision to execute an index-based hedge requires a framework for (1) developing an informed understanding of the basis risk, (2) appropriately calibrating the hedging instrument, and (3) evaluating hedge effectiveness. We describe such a framework and apply it to a U.K. case study, which compares the population of assured lives from the Continuous Mortality Investigation with the England and Wales national population. The framework is founded on an analysis of historical experience data, together with an appreciation of the contextual relationship between the two related populations in social, economic, and demographic terms. Despite the different demographic profiles, the case study provides evidence of stable long-term relationships between the mortality experiences of the two populations. This suggests the important result that high levels of hedge effectiveness should be achievable with appropriately calibrated, static, index-based longevity hedges. Indeed, this is borne out in detailed calculations of hedge effectiveness for a hypothetical pension portfolio where the basis risk is based on the case study. A robustness check involving populations from the United States yields similar results.

Keywords: Longevity hedging, longevity index, longevity basis risk, stochastic mortality, two populations, hedge effectiveness

JEL Classification: G22

Suggested Citation

Coughlan, Guy and Khalaf-Allah, Marwa and Ye, Yijing and Kumar, Sumit and Cairns, Andrew J. G. and Blake, David P. and Dowd, Kevin, Longevity Hedging 101: A Framework for Longevity Basis Risk Analysis and Hedge Effectiveness (2011). North American Actuarial Journal, Volume 15, Number 2, 2011, Available at SSRN: https://ssrn.com/abstract=1969370

Guy Coughlan

Pacific Global Advisors ( email )

535 Madison Avenue
Floor 14
New York, NY 10022
United States
+1-212-405-6340 (Phone)

HOME PAGE: http://www.PacificGlobalAdvisors.com

Marwa Khalaf-Allah

J.P. Morgan ( email )

25 Bank Street
London, E14 5JP
United Kingdom

Yijing Ye

affiliation not provided to SSRN

Sumit Kumar

Maharaja Agrasen Institute of Technology ( email )

New Delhi, 110086
India

Andrew J. G. Cairns

Heriot-Watt University - Department of Actuarial Science & Statistics ( email )

Edinburgh, Scotland EH14 4AS
United Kingdom

David P. Blake (Contact Author)

City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZX
Great Britain
+44 (0) 20-7040-8600 (Phone)
+44 (0) 20-7040-8881 (Fax)

HOME PAGE: http://www.pensions-institute.org/

Kevin Dowd

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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