Forward thinking

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, contracting parties will want to use stochastic projection models to assess potential payoffs or losses and how likely they might be.

The advent of the survivor forward will enable pension schemes and annuity portfolios to partially hedge their exposure to mortality improvements. It will also enable investors in longevity risk to gain exposure without having to worry about the peculiarities of a specific portfolio, such as concentration risk. A particular advantage for all concerned may be the ability to draw additional capital into the market. Hitherto investors had to buy exposure to longevity risk via an insurer or reinsurer, along with the attendant risk in interest rates, credit risk and regulatory risk.  These extra risks would have put off some investors, but now they can get purer exposure to longevity risk on its own via survivor forwards.  This will expand capital capacity for managing longevity risk in pension schemes and annuity portfolios.

 

Comments

Albert Jürgen Enders
(Nov 16, 2010)
Hedging longevity risk with Survivor Swaps is a good concept. It is important, that the "S" covers the cumulated mortality rates from the start of the swap until maturity. Thus, als lx works good. At Xpect Indices of Deutsche Börse we defined lx as the metric for the Xpect Indices.

Investors are rather interested in buying an index-linked longevity swap instead of a indenmity longevity swap. The reason is quite simple: as an investor I do not care that much about the scheme but want to "bet" against an underlying that I can predict.
Stephen Richards
(Nov 16, 2010)
The survival curve is just a standardised version of the life-table curve l_{x+t}, so an investor will be just as happy with with an "l_x forward" as a "survivor forward".
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Stephen Richards
Stephen Richards is the Managing Director of Longevitas
Survivor forwards and the Projections Toolkit
The Projections Toolkit provides a matrix of mortality improvements which can be pasted directly into the LLMA valuation spreadsheets.  Simply set the file type to Excel® in the Notifications and downloads configuration, then download the Log MU file which is produced for every projection.  You can specify a stress scenario of a given likelihood in the Analysis tab, then copy the contents of the Improvements tab straight into the LLMA spreadsheets.