Pricing of longevity derivatives and cost of capital

Annuities providers become more and more exposed to longevity risk due to the increase in life expectancy. To hedge this risk, new longevity derivatives have been proposed (longevity bonds, q-forwards, S-swaps...). Although academic researchers, policy makers and practitioners have talked about it f...

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Bibliographic Details
Published in:Risks (Basel) 2019-06, Vol.7 (2), p.1-29
Main Authors: Zeddouk, Fadoua, Devolder, Pierre
Format: Article
Language:English
Subjects:
Hedging
Insurance industry
Interest rate swaps
Mortality
Random variables
S-forward
S-swap
Securities markets
Solvency
solvency capital requirement
stochastic longevity risk
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Summary:Annuities providers become more and more exposed to longevity risk due to the increase in life expectancy. To hedge this risk, new longevity derivatives have been proposed (longevity bonds, q-forwards, S-swaps...). Although academic researchers, policy makers and practitioners have talked about it for years, longevity-linked securities are not widely traded in financial markets, due in particular to the pricing difficulty. In this paper, we compare different existing pricing methods and propose a Cost of Capital approach. Our method is designed to be more consistent with Solvency II requirement (longevity risk assessment is based on a one year time horizon). The price of longevity risk is determined for a S-forward and a S-swap but can be used to price other longevity-linked securities. We also compare this Cost of capital method with some classical pricing approaches. The Hull and White and CIR extended models are used to represent the evolution of mortality over time. We use data for Belgian population to derive prices for the proposed longevity linked securities based on the different methods.
ISSN:2227-9091
2227-9091
DOI:10.3390/risks7020041