Towards a Large and Liquid Longevity Market: A Graphical Population Basis Risk Metric

• Published in: Geneva papers on risk and insurance. Issues and practice Vol. 41; no. 1; pp. 118 - 127
• Main Authors: Chan, Wai-Sum, Li, Johnny S.-H., Zhou, Kenneth Q., Zhou, Rui
• Format: Journal Article
• Language: English
• Published: London Palgrave Macmillan 01.01.2016; Palgrave Macmillan UK
• Subjects: Capital markets; Economics and Finance; Expected values; Finance; Hedging; Insurance; Liability; Life expectancy; Mortality; Original Article; Pension plans; Population; Probability; Risk exposure; Risk Management; longevity risk; prediction regions; basis risk
• ISSN: 1018-5895; 1468-0440
• DOI: 10.1057/gpp.2015.9

Pension plan sponsors and annuity providers can offload their longevity risk exposures by trading securities that are linked to broad-based mortality indexes. However, a hedge constructed in this way is subject to population basis risk, arising from the difference in mortality improvements between the hedger's population and the reference population to which the security is linked. To address this problem, which is believed to be a major obstacle to market development, in this paper we contribute a graphical population basis risk metric. The graphical metric allows market participants to not only visually evaluate the extent of population basis risk, but also determine the most appropriate reference population. We illustrate this concept with a hypothetical example.