Immunization and Hedging of Longevity Risk

39 Pages Posted: 23 Apr 2015

See all articles by Changyu Liu

Changyu Liu

School of Risk & Actuarial Studies

Michael Sherris

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies; UNSW Australia Business School

Date Written: April 21, 2015

Abstract

Pension funds and life insurers offering annuities hold long term liabilities linked to longevity. Risk management of life annuity portfolios aims to immunize or hedge both interest rate and mortality risks. Standard fixed interest duration-convexity hedging must be adapted to allow for both interest rate and longevity risk. We develop an immunization approach along with a delta-gamma based approach allowing for both risks incorporating models for mortality and interest rate risk. The immunization and hedge effectiveness of fixed-income coupon bonds, annuity bonds, as well as longevity bonds, is compared and assessed using simulations of portfolio surplus outcomes for an annuity portfolio. Fixed-income annuity bonds can more effectively match cash flows and provide additional hedge effectiveness over coupon bonds. Longevity bonds, including deferred longevity bonds, reduce risk significantly compared to coupon and annuity bonds, reflecting the long duration of the typical life annuity and the exposure to longevity risk. Longevity bonds are shown to be effective in immunizing surplus over short and long horizons. Delta gamma hedging is shown to only be effective over short horizons.

Keywords: immunization, hedging, delta, gamma, longevity bond

JEL Classification: G11, G22, C61

Suggested Citation

Liu, Changyu and Sherris, Michael, Immunization and Hedging of Longevity Risk (April 21, 2015). UNSW Business School Research Paper No. 2015ACTL12. Available at SSRN: https://ssrn.com/abstract=2596989 or http://dx.doi.org/10.2139/ssrn.2596989

Changyu Liu

School of Risk & Actuarial Studies ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia

Michael Sherris (Contact Author)

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies ( email )

UNSW Business School
Risk and Actuarial Studies
Sydney, NSW 2052
Australia
+61 2 9385 2333 (Phone)
+61 2 9385 1883 (Fax)

HOME PAGE: http://www.asb.unsw.edu.au/schools/Pages/MichaelSherris.aspx

UNSW Australia Business School ( email )

Sydney, NSW 2052
Australia

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