UK - Mortality linked securities can aid pension schemes more effectively hedge their longevity risks, according to leading pensions and actuarial experts in the UK
In a paper to be presented to the Faculty of Actuaries today, David Blake (pictured) of the Pensions Institute, Cass Business School, Andrew Cairns of the Heriot-Watt University and Nottingham University Business School’s Kevin Dowd will discuss the need for the industry as a whole to deal with issues of longevity risk, of which part of the answer for pension plans is the access to suitable hedge instruments.
The authors of Living With Mortality: Longetivy Bonds And Other Mortality-Linked Securities, argued a well designed security will help hedgers to reduce substantially” their exposure to longevity risk.
They warned it is essential the mortality experience of the specific security’s reference population matches the hedger’s mortality experience as accurately as possible.
Where perfect hedging is not possible there is a basis risk, the authors argued. The higher the risk basis gets, the less likely that pension funds will use these contracts for hedging.
Certain bonds such as the EIB bond (which attempted to deal with longevity risk) failed because, according to the paper some of its design features probably discouraged investors, notably excessive basis risk and the fact the bond required a high level of upfront capital for the level of hedging it offered.
The paper expressed the belief that in the long run a range of suitably-graded mortality indices will be developed that can be referenced in traded securities.
“The problem of upfront costs could be dealt with by increasing gearing or by using derivatives rather than spot market securities,” Cairns noted
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