Assessing Basis Risk for Longevity Transactions

Abstract

Longevity basis risk arises because different populations, or subpopulations, will inevitably experience different longevity outcomes. This is a significant issue for those wishing to hedge longevity risk using a published mortality index – whether they be pension schemes, insurers, reinsurers, or banks. Put simply, actual longevity outcomes, and therefore cashflows, of the hedged portfolio will differ from those under the hedging instrument.

In addition, longevity basis risk can also present a wider issue for insurers using, in their reserving models, external data, such as population data, rather than their own policy data. The need to quantify any potential basis risk is receiving increasing focus, particularly under Solvency II.

Keywords: longevity risk, longevity basis risk, index-based hedging, longevity swap, hedge effectiveness

JEL Classification: G22