Financial Engineering: A Flexible Longevity Bond to Manage Individual Longevity Risk

35 Pages Posted: 14 May 2020

See all articles by Yuxin Zhou

Yuxin Zhou

School of Risk and Actuarial Studies, UNSW Business School

Michael Sherris

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

Jonathan Ziveyi

University of New South Wales; ARC Centre of Excellence in Population Ageing Research and School of Risk & Actuarial Studies

Mengyi Xu

Purdue University; University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR)

Date Written: April 20, 2020

Abstract

There is a significant potential demand in many countries around the world for a flexible product to manage individual longevity risk arising from the prevalence of defined contribution pensions, uncertainty in improvements in life expectancy, potential reductions in public pensions and a lack of suitable longevity insurance products. The classical insurance product to manage individual longevity risk is the life annuity. Annuity markets remain thin, driven by many factors including lack of transparency in pricing, high product loading, bequest motives, lack of liquidity and loss aversion. This paper proposes an individual longevity bond, not currently available, as a combined investment and insurance product to allow individuals to flexibly manage their longevity risk. The bond is a post-retirement product that combines a lifetime income along with a flexible death benefit to meet bequest and liquidity needs. The longevity bonds are issued through a special purpose vehicle which is fully collateralized with a fixed interest portfolio. We apply financial and actuarial models and techniques that provide transparent pricing for interest rate and mortality risk, the construction of optimally immunized bond portfolios and the determination of a loading and solvency margin for systematic longevity risk. We also quantify the natural hedging benefits of the individual bond cash flows arising from the flexible inclusion of both survival dependent income benefits and mortality dependent bequest benefits payable on death.

Keywords: Longevity Risk, Stochastic Mortality, Longevity Bond, Immunization, Natural Hedging

JEL Classification: G11, G22, G23, C53, C58, C61

Suggested Citation

Zhou, Yuxin and Sherris, Michael and Ziveyi, Jonathan and Xu, Mengyi, Financial Engineering: A Flexible Longevity Bond to Manage Individual Longevity Risk (April 20, 2020). Available at SSRN: https://ssrn.com/abstract=3580488 or http://dx.doi.org/10.2139/ssrn.3580488

Yuxin Zhou

School of Risk and Actuarial Studies, UNSW Business School ( email )

Room 2058 South Wing 2nd Floor
Quadrangle building Kensington Campus
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 Business School ( email )

Sydney, NSW 2052
Australia

Jonathan Ziveyi

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

School of Risk and Actuarial Studies
UNSW Business School
Sydney, NSW 2000
Australia
+61 2 9065 8254 (Phone)
+61 2 9385 1883 (Fax)

Mengyi Xu

Purdue University ( email )

610 Purdue Mall
West Lafayette, IN 47907
United States

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

Level 6, Central Lobby (enter via East Lobby)
Australian School of Business Building
Sydney, New South Wales NSW 2052
Australia

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