Haircut or hedge-trim?

(Jul 4, 2013)

Richard Willet's observation last year on the restatement of population estimates was picked up again recently by the BBC.  Amongst the implications of the missing nonagenarians are some potentially interesting consequences for index-based longevity hedges. These are derivative contracts based on population mortality data. The idea is that an organisation holding longevity risk, such as an insurer or pension fund, would buy or sell an appropriate instrument to transfer risk to an investor willing to take it. The portfolio being hedged will not have the same mortality dynamics as the population - so-called basis risk - but the idea is that the hedge will provide at least partial protection.

Imagine…

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Tags: ONS, longevity hedge, basis risk, S-forward

A basis point

(Jun 7, 2011)

In an earlier post I mentioned the advent of survivor forwards, or S-forwards, a derivative contract which could be used for hedging pension liabilities.  Survivor forwards appeared again in another post illustrating the financial impact of model risk.

A survivor forward defined on an index of, say, population mortality will give a large data set with considerable history on which to base a projection model.  However, a natural question is to ask how suitable such a contract would be for hedging pension or annuitant liabilities?  Figure 1 shows the Kaplan-Meier survival curve from age 70 for male annuitants born in 1928, together with the corresponding survival curve for males in England & Wales.

Figure…

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Tags: survivor forward, S-forward, hedging, basis risk

Caveat emptor

(Apr 13, 2011)

I wrote earlier about survivor forwards as a means of transferring longevity risk.  One natural question for investors to ask is: what is the likelihood of loss exceeding a given amount?  The only sensible means of answering this question is to use a stochastic projection model - a deterministic model generates scenarios, but without attaching probabilities it cannot be used to approach this problem.

Consider an example where Party A (a pension scheme, say) offers a survivor forward based on males in England and Wales.  Party A offers to pay a fixed rate of 0.47 per £10 million nominal for survivors between age 60 and 85.  The investor, Party B, is asked to pay the floating leg, i.e. the actual survival rate, S. …

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Tags: survivor forward, S-forward, model risk, mortality improvements, mortality projections

Forward thinking

(Nov 10, 2010)

A forward contract is an agreement between two parties to buy or sell an asset at a specified price at a date in the future. It is typically a private arrangement used by one or both parties to manage their risk, or where one party wishes to speculate.

A new innovation is the idea of a survivor forward, or S-forward, which is based on the concept of the survival curve. The two parties will agree on what the neutral or best-estimate survival probability will be to a certain age, and the actual survival probability will determine who pays whom and how much. If the two parties do not agree on a neutral survival probability, one may pay the other a premium. Since the future survival curve involves considerable uncertainty,…

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Tags: survivor forward, S-forward, survival curve

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