IDEAS home Printed from https://ideas.repec.org/a/eee/insuma/v114y2024icp242-251.html
   My bibliography  Save this article

Longevity hedge effectiveness using socioeconomic indices

Author

Listed:
  • Kallestrup-Lamb, Malene
  • Søgaard Laursen, Nicolai

Abstract

This paper evaluates socioeconomic basis risk in longevity hedging. Using data for a full population stratified into socioeconomic groups, we explore the benefits and costs of two alternative hedging strategies, with and without basis risk, in the capital market. The benefit of the longevity hedge is represented by the risk reduction in the variability of a life annuity, whereas the cost is the notional amount of hedging contracts times the actuarial risk premium. We find that hedging is more cost-effective for the annuity provider when basis risk is eliminated. Moreover, it allows for a higher degree of hedge effectiveness at a cost that is equivalent to a hedge where basis risk is present. Finally, the yearly expenses related to hedging longevity risk require, at most, an extra added rate of return of no more than 0.16%.

Suggested Citation

  • Kallestrup-Lamb, Malene & Søgaard Laursen, Nicolai, 2024. "Longevity hedge effectiveness using socioeconomic indices," Insurance: Mathematics and Economics, Elsevier, vol. 114(C), pages 242-251.
    • Handle: RePEc:eee:insuma:v:114:y:2024:i:c:p:242-251
    DOI: 10.1016/j.insmatheco.2023.11.008
    as

    Download full text from publisher

    File URL: https://www.sciencedirect.com/science/article/pii/S0167668723001026
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.insmatheco.2023.11.008?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Barrieu, Pauline & Veraart, Luitgard A. M., 2016. "Pricing q-forward contracts: an evaluation of estimation window and pricing method under different mortality models," LSE Research Online Documents on Economics 58742, London School of Economics and Political Science, LSE Library.
    2. Ngai, Andrew & Sherris, Michael, 2011. "Longevity risk management for life and variable annuities: The effectiveness of static hedging using longevity bonds and derivatives," Insurance: Mathematics and Economics, Elsevier, vol. 49(1), pages 100-114, July.
    3. Pablo Antolin, 2007. "Longevity Risk and Private Pensions," Financial Market Trends, OECD Publishing, vol. 2007(1), pages 107-128.
    4. Indranarain Ramlall, 2010. "Reasons Motivating Firms to Hedge: A Review of the Empirical Literature," The IUP Journal of Financial Economics, IUP Publications, vol. 0(1 & 2), pages 67-81, March & J.
    5. Ragnar Norberg, 1999. "A theory of bonus in life insurance," Finance and Stochastics, Springer, vol. 3(4), pages 373-390.
    6. Cairns, Andrew J.G. & Kallestrup-Lamb, Malene & Rosenskjold, Carsten & Blake, David & Dowd, Kevin, 2019. "Modelling Socio-Economic Differences In Mortality Using A New Affluence Index," ASTIN Bulletin, Cambridge University Press, vol. 49(3), pages 555-590, September.
    7. Peter R. Hansen & Asger Lunde & James M. Nason, 2011. "The Model Confidence Set," Econometrica, Econometric Society, vol. 79(2), pages 453-497, March.
    8. Dustin Brown & Mark Hayward & Jennifer Montez & Robert Hummer & Chi-Tsun Chiu & Mira Hidajat, 2012. "The Significance of Education for Mortality Compression in the United States," Demography, Springer;Population Association of America (PAA), vol. 49(3), pages 819-840, August.
    9. Shao, Adam W. & Hanewald, Katja & Sherris, Michael, 2015. "Reverse mortgage pricing and risk analysis allowing for idiosyncratic house price risk and longevity risk," Insurance: Mathematics and Economics, Elsevier, vol. 63(C), pages 76-90.
    10. Boyer, M. Martin & Stentoft, Lars, 2013. "If we can simulate it, we can insure it: An application to longevity risk management," Insurance: Mathematics and Economics, Elsevier, vol. 52(1), pages 35-45.
    11. Pauline Barrieu & Harry Bensusan & Nicole El Karoui & Caroline Hillairet & Stéphane Loisel & Claudia Ravanelli & Yahia Salhi, 2012. "Understanding, modelling and managing longevity risk: key issues and main challenges," Scandinavian Actuarial Journal, Taylor & Francis Journals, vol. 2012(3), pages 203-231.
    12. Villegas, Andrés M. & Haberman, Steven & Kaishev, Vladimir K. & Millossovich, Pietro, 2017. "A Comparative Study Of Two-Population Models For The Assessment Of Basis Risk In Longevity Hedges," ASTIN Bulletin, Cambridge University Press, vol. 47(3), pages 631-679, September.
    13. Torben M. Andersen, 2015. "Robustness of the Danish Pension System," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 13(2), pages 25-30, 08.
    14. Andrew Hunt & David Blake, 2021. "Forward Mortality Rates in Discrete Time II: Longevity Risk and Hedging Strategies," North American Actuarial Journal, Taylor & Francis Journals, vol. 25(S1), pages 508-533, February.
    15. Kijima, Masaaki, 2006. "A Multivariate Extension of Equilibrium Pricing Transforms: The Multivariate Esscher and Wang Transforms for Pricing Financial and Insurance Risks," ASTIN Bulletin, Cambridge University Press, vol. 36(1), pages 269-283, May.
    16. S⊘ren Kjærgaard & Yunus Emre Ergemen & Marie‐Pier Bergeron‐Boucher & Jim Oeppen & Malene Kallestrup‐Lamb, 2020. "Longevity forecasting by socio‐economic groups using compositional data analysis," Journal of the Royal Statistical Society Series A, Royal Statistical Society, vol. 183(3), pages 1167-1187, June.
    17. repec:ces:ifodic:v:13:y:2015:i:2:p:19166293 is not listed on IDEAS
    18. Andrew J. G. Cairns & David Blake & Kevin Dowd, 2006. "A Two‐Factor Model for Stochastic Mortality with Parameter Uncertainty: Theory and Calibration," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(4), pages 687-718, December.
    19. Mr. John Kiff & Michael Kisser & Mauricio Soto & Mr. S. E Oppers, 2012. "The Impact of Longevity Improvements on U.S. Corporate Defined Benefit Pension Plans," IMF Working Papers 2012/170, International Monetary Fund.
    20. Enrico Biffis & David Blake, 2014. "Keeping Some Skin in the Game: How to Start a Capital Market in Longevity Risk Transfers," North American Actuarial Journal, Taylor & Francis Journals, vol. 18(1), pages 14-21.
    21. Jennifer L. Wang & H.C. Huang & Sharon S. Yang & Jeffrey T. Tsai, 2010. "An Optimal Product Mix for Hedging Longevity Risk in Life Insurance Companies: The Immunization Theory Approach," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(2), pages 473-497, June.
    22. Neeru Chaudhry & Hue Hwa Au Yong & Chris Veld, 2017. "How does the Funding Status of Defined Benefit Pension Plans Affect Investment Decisions of Firms in the United States?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 44(1-2), pages 196-235, January.
    23. Mikkel Dahl & Martin Melchior & Thomas Møller, 2008. "On systematic mortality risk and risk-minimization with survivor swaps," Scandinavian Actuarial Journal, Taylor & Francis Journals, vol. 2008(2-3), pages 114-146.
    24. Bravo, Jorge M. & Nunes, João Pedro Vidal, 2021. "Pricing longevity derivatives via Fourier transforms," Insurance: Mathematics and Economics, Elsevier, vol. 96(C), pages 81-97.
    25. Bates, David S., 2003. "Empirical option pricing: a retrospection," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 387-404.
    26. Blake, D. & Cairns, A. J. G. & Dowd, K., 2006. "Living with Mortality: Longevity Bonds and Other Mortality-Linked Securities," British Actuarial Journal, Cambridge University Press, vol. 12(1), pages 153-197, March.
    27. Nan Li & Ronald Lee, 2005. "Coherent mortality forecasts for a group of populations: An extension of the lee-carter method," Demography, Springer;Population Association of America (PAA), vol. 42(3), pages 575-594, August.
    28. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    29. Börger, Matthias & Freimann, Arne & Ruß, Jochen, 2021. "A combined analysis of hedge effectiveness and capital efficiency in longevity hedging," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 309-326.
    30. Andrew J.G. Cairns & Kevin Dowd & David Blake & Guy D. Coughlan, 2014. "Longevity hedge effectiveness: a decomposition," Quantitative Finance, Taylor & Francis Journals, vol. 14(2), pages 217-235, February.
    31. John Lintner, 1965. "Security Prices, Risk, And Maximal Gains From Diversification," Journal of Finance, American Finance Association, vol. 20(4), pages 587-615, December.
    32. David Blake & Andrew Cairns & Guy Coughlan & Kevin Dowd & Richard MacMinn, 2013. "The New Life Market," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 80(3), pages 501-558, September.
    33. Coughlan, Guy & Khalaf-Allah, Marwa & Ye, Yijing & Kumar, Sumit & Cairns, Andrew & Blake, David & Dowd, Kevin, 2011. "Longevity hedging 101: A framework for longevity basis risk analysis and hedge effectiveness," MPRA Paper 35743, University Library of Munich, Germany.
    34. Vasil Enchev & Torsten Kleinow & Andrew J. G. Cairns, 2017. "Multi-population mortality models: fitting, forecasting and comparisons," Scandinavian Actuarial Journal, Taylor & Francis Journals, vol. 2017(4), pages 319-342, April.
    35. Pauline M. Barrieu & Luitgard A.M. Veraart, 2016. "Pricing q-forward contracts: an evaluation of estimation window and pricing method under different mortality models," Scandinavian Actuarial Journal, Taylor & Francis Journals, vol. 2016(2), pages 146-166, February.
    36. repec:cup:bracjl:v:24:y:2018:i::p:-_1 is not listed on IDEAS
    37. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    38. Li, Jackie & Li, Johnny Siu-Hang & Tan, Chong It & Tickle, Leonie, 2019. "Assessing basis risk in index-based longevity swap transactions," Annals of Actuarial Science, Cambridge University Press, vol. 13(1), pages 166-197, March.
    39. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    40. Hári, Norbert & De Waegenaere, Anja & Melenberg, Bertrand & Nijman, Theo E., 2008. "Longevity risk in portfolios of pension annuities," Insurance: Mathematics and Economics, Elsevier, vol. 42(2), pages 505-519, April.
    41. Li, Johnny Siu-Hang & Luo, Ancheng, 2012. "Key Q-Duration: A Framework for Hedging Longevity Risk," ASTIN Bulletin, Cambridge University Press, vol. 42(2), pages 413-452, November.
    42. Cairns, Andrew J.G. & Blake, David & Dowd, Kevin, 2006. "Pricing Death: Frameworks for the Valuation and Securitization of Mortality Risk," ASTIN Bulletin, Cambridge University Press, vol. 36(1), pages 79-120, May.
    43. Balter, Anne G. & Kallestrup-Lamb, Malene & Rangvid, Jesper, 2020. "Variability in pension products: a comparison study between The Netherlands and Denmark," Annals of Actuarial Science, Cambridge University Press, vol. 14(2), pages 338-357, September.
    44. Labuschagne, Coenraad C.A. & Offwood, Theresa M., 2010. "A note on the connection between the Esscher-Girsanov transform and the Wang transform," Insurance: Mathematics and Economics, Elsevier, vol. 47(3), pages 385-390, December.
    45. Andrew J. G. Cairns & Ghali El Boukfaoui, 2021. "Basis Risk in Index-Based Longevity Hedges: A Guide for Longevity Hedgers," North American Actuarial Journal, Taylor & Francis Journals, vol. 25(S1), pages 97-118, February.
    46. Yijia Lin & Samuel H. Cox, 2005. "Securitization of Mortality Risks in Life Annuities," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 72(2), pages 227-252, June.
    47. Johnny Li & Mary Hardy, 2011. "Measuring Basis Risk in Longevity Hedges," North American Actuarial Journal, Taylor & Francis Journals, vol. 15(2), pages 177-200.
    48. Pitacco, Ermanno & Denuit, Michel & Haberman, Steven & Olivieri, Annamaria, 2009. "Modelling Longevity Dynamics for Pensions and Annuity Business," OUP Catalogue, Oxford University Press, number 9780199547272.
    49. Torben M. Andersen, 2015. "Robustness of the Danish Pension System," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 13(02), pages 25-30, August.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Blake, David & Cairns, Andrew J.G., 2021. "Longevity risk and capital markets: The 2019-20 update," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 395-439.
    2. Blake, David & El Karoui, Nicole & Loisel, Stéphane & MacMinn, Richard, 2018. "Longevity risk and capital markets: The 2015–16 update," Insurance: Mathematics and Economics, Elsevier, vol. 78(C), pages 157-173.
    3. Man Chung Fung & Katja Ignatieva & Michael Sherris, 2019. "Managing Systematic Mortality Risk in Life Annuities: An Application of Longevity Derivatives," Risks, MDPI, vol. 7(1), pages 1-25, January.
    4. Tan, Ken Seng & Weng, Chengguo & Zhang, Jinggong, 2022. "Optimal dynamic longevity hedge with basis risk," European Journal of Operational Research, Elsevier, vol. 297(1), pages 325-337.
    5. Liu, Yanxin & Li, Johnny Siu-Hang, 2018. "A strategy for hedging risks associated with period and cohort effects using q-forwards," Insurance: Mathematics and Economics, Elsevier, vol. 78(C), pages 267-285.
    6. David Blake & Marco Morales & Enrico Biffis & Yijia Lin & Andreas Milidonis, 2017. "Special Edition: Longevity 10 – The Tenth International Longevity Risk and Capital Markets Solutions Conference," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 84(S1), pages 515-532, April.
    7. Man Chung Fung & Katja Ignatieva & Michael Sherris, 2015. "Managing Systematic Mortality Risk in Life Annuities: An Application of Longevity Derivatives," Papers 1508.00090, arXiv.org.
    8. Liu, Yanxin & Li, Johnny Siu-Hang, 2016. "It’s all in the hidden states: A longevity hedging strategy with an explicit measure of population basis risk," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 301-319.
    9. Börger, Matthias & Freimann, Arne & Ruß, Jochen, 2021. "A combined analysis of hedge effectiveness and capital efficiency in longevity hedging," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 309-326.
    10. Selin Özen & Şule Şahin, 2021. "A Two-Population Mortality Model to Assess Longevity Basis Risk," Risks, MDPI, vol. 9(2), pages 1-19, February.
    11. Bravo, Jorge M. & Ayuso, Mercedes & Holzmann, Robert & Palmer, Edward, 2021. "Addressing the life expectancy gap in pension policy," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 200-221.
    12. Hunt, Andrew & Blake, David, 2015. "Modelling longevity bonds: Analysing the Swiss Re Kortis bond," Insurance: Mathematics and Economics, Elsevier, vol. 63(C), pages 12-29.
    13. Zeddouk, Fadoua & Devolder, Pierre, 2022. "Pricing and hedging of longevity basis risk through securitization," LIDAM Discussion Papers ISBA 2022038, Université catholique de Louvain, Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA).
    14. Alvarez, Jesús-Adrián & Kallestrup-Lamb, Malene & Kjærgaard, Søren, 2021. "Linking retirement age to life expectancy does not lessen the demographic implications of unequal lifespans," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 363-375.
    15. Hanbali, Hamza & Dhaene, Jan & Linders, Daniël, 2022. "Dependence bounds for the difference of stop-loss payoffs on the difference of two random variables," Insurance: Mathematics and Economics, Elsevier, vol. 107(C), pages 22-37.
    16. Selin Ozen & c{S}ule c{S}ahin, 2021. "A Two-Population Mortality Model to Assess Longevity Basis Risk," Papers 2101.06690, arXiv.org.
    17. Jesús-Adrián Álvarez & Malene Kallestrup-Lamb & Søren Kjærgaard, 2020. "Linking retirement age to life expectancy does not lessen the demographic implications of unequal lifespans," CREATES Research Papers 2020-17, Department of Economics and Business Economics, Aarhus University.
    18. Zhou, Kenneth Q. & Li, Johnny Siu-Hang, 2019. "Delta-hedging longevity risk under the M7–M5 model: The impact of cohort effect uncertainty and population basis risk," Insurance: Mathematics and Economics, Elsevier, vol. 84(C), pages 1-21.
    19. Chen, An & Li, Hong & Schultze, Mark, 2022. "Collective longevity swap: A novel longevity risk transfer solution and its economic pricing," Journal of Economic Behavior & Organization, Elsevier, vol. 201(C), pages 227-249.
    20. Susanna Levantesi & Massimiliano Menzietti, 2017. "Maximum Market Price of Longevity Risk under Solvency Regimes: The Case of Solvency II," Risks, MDPI, vol. 5(2), pages 1-21, May.

    More about this item

    Keywords

    Longevity risk; Hedge effectiveness; Basis risk; Socioeconomic groups; Static hedging; Q-forwards;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • I14 - Health, Education, and Welfare - - Health - - - Health and Inequality

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:insuma:v:114:y:2024:i:c:p:242-251. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: https://www.elsevier.com/locate/inca/505554 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.