Downside Risk Management of a Defined Benefit Plan Considering Longevity Basis Risk

North American Actuarial Journal, Vol. 18, No. 1, pp. 68-86, 2014

39 Pages Posted: 3 Oct 2013 Last revised: 25 May 2014

See all articles by Yijia Lin

Yijia Lin

University of Nebraska at Lincoln - Department of Finance

Ken Seng Tan

University of Waterloo

Ruilin Tian

North Dakota State University - Department of Accounting, Finance, and Information Systems

Jifeng Yu

University of Nebraska-Lincoln

Date Written: June 24, 2013

Abstract

To control downside risk of a defined benefit (DB) pension plan arising from unexpected mortality improvements and severe market turbulence, this paper proposes an optimization model by imposing two conditional value at risk (CVaR) constraints to control tail risks of pension funding status and total pension costs. With this setup, we further examine two longevity risk hedging strategies subject to basis risk. While the existing literature suggests that the excess-risk hedging strategy is more attractive than the ground-up hedging strategy as the latter is more capital intensive and expensive, our numerical examples show that the excess-risk hedging strategy is much more vulnerable to longevity basis risk, which limits its applications for pension longevity risk management. Hence, our findings provide important insight on the effect of basis risk on longevity hedging strategies.

Keywords: defined benefit pension plan, downside risk, basis risk, CVaR, longevity risk hedging

JEL Classification: C61, G11, G23

Suggested Citation

Lin, Yijia and Tan, Ken Seng and Tian, Ruilin and Yu, Jifeng, Downside Risk Management of a Defined Benefit Plan Considering Longevity Basis Risk (June 24, 2013). North American Actuarial Journal, Vol. 18, No. 1, pp. 68-86, 2014, Available at SSRN: https://ssrn.com/abstract=2334563

Yijia Lin (Contact Author)

University of Nebraska at Lincoln - Department of Finance ( email )

Lincoln, NE 68588-0490
United States

Ken Seng Tan

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

Ruilin Tian

North Dakota State University - Department of Accounting, Finance, and Information Systems ( email )

Fargo, ND
United States
7012316544 (Phone)
7012316545 (Fax)

Jifeng Yu

University of Nebraska-Lincoln ( email )

United States

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