Hedging Brevity Risk with Mortality-based Securities

In 2003, Swiss Re introduced a mortality-based security designed to hedge excessive mortality changes for its life book of business. The concern was apparently brevity risk, i.e., the risk of premature death. The brevity risk due to a pandemic is similar to the property risk associated with catastrophic events such as earthquakes and hurricanes and the security used to hedge the risk is similar to a CAT bond. This work looks at the incentives associated with insurance-linked securities. It considers the trade-offs an insurer or reinsurer faces in selecting a hedging strategy. We compare index and indemnity-based hedging as alternative design choices and ask which is capable of creating the greater value for shareholders. Additionally, we model an insurer or reinsurer that is subject to insolvency risk, which creates an incentive problem known as the judgment proof problem. The corporate manager is assumed to act in the interests of shareholders and so the judgment proof problem yields a conflict of interest between shareholders and other stakeholders. Given the fact that hedging may improve the situation, the analysis addresses what type of hedging tool would be best to use. We show that an indemnity-based security tends to worsen the situation, as it introduces an additional incentive problem. Index-based hedging, on the other hand, under certain conditions turns out to be beneficial and therefore clearly dominates indemnity-based strategies. This result is further supported by showing that for the same strike prices the current shareholder value is greater with the index-based security than the indemnity-based security

Select Birth Cohorts

Worldwide demographic changes and their implications for governments, corporations, and individuals have been in the focus of public interest for quite some time due to the fiscal risk related to adequate retirement benefits. Through a more detailed analysis of mortality data an additional type of risk can be identified: differences in mortality improvements by birth year, also known as "cohort effects." Previous contributions have, however, not formalized a suitable measure to further investigate mortality improvements but rather relied on graphical representations without particular focus on individual cohorts but groups of the overall population. No criterion to identify single birth year cohorts as select has been established. A simple criterion for identifying select cohorts is proposed and used here to what country mortality data reveals about the mortality and longevity experience of cohorts. Select cohorts are rare but can be quite different from surrounding cohorts and so may generate financial risks that need to be hedged naturally or artificially with new ART instruments.mortality improvement; longevity trend; select cohort; longevity risk

Select Birth Cohorts

Worldwide demographic changes and their implications for governments, corporations, and individuals have been in the focus of public interest for quite some time due to the fiscal risk related to adequate retirement benefits. Through a more detailed analysis of mortality data an additional type of risk can be identified: differences in mortality improvements by birth year, also known as "cohort effects." Previous contributions have, however, not formalized a suitable measure to further investigate mortality improvements but rather relied on graphical representations without particular focus on individual cohorts but groups of the overall population. No criterion to identify single birth year cohorts as select has been established. A simple criterion for identifying select cohorts is proposed and used here to what country mortality data reveals about the mortality and longevity experience of cohorts. Select cohorts are rare but can be quite different from surrounding cohorts and so may generate financial risks that need to be hedged naturally or artificially with new ART instruments

Hedging Brevity Risk with Mortality-based Securities

In 2003, Swiss Re introduced a mortality-based security designed to hedge excessive mortality changes for its life book of business. The concern was apparently brevity risk, i.e., the risk of premature death. The brevity risk due to a pandemic is similar to the property risk associated with catastrophic events such as earthquakes and hurricanes and the security used to hedge the risk is similar to a CAT bond. This work looks at the incentives associated with insurance-linked securities. It considers the trade-offs an insurer or reinsurer faces in selecting a hedging strategy. We compare index and indemnity-based hedging as alternative design choices and ask which is capable of creating the greater value for shareholders. Additionally, we model an insurer or reinsurer that is subject to insolvency risk, which creates an incentive problem known as the judgment proof problem. The corporate manager is assumed to act in the interests of shareholders and so the judgment proof problem yields a conflict of interest between shareholders and other stakeholders. Given the fact that hedging may improve the situation, the analysis addresses what type of hedging tool would be best to use. We show that an indemnity-based security tends to worsen the situation, as it introduces an additional incentive problem. Index-based hedging, on the other hand, under certain conditions turns out to be beneficial and therefore clearly dominates indemnity-based strategies. This result is further supported by showing that for the same strike prices the current shareholder value is greater with the index-based security than the indemnity-based security.alternative risk transfer; insurance; default risk

Constraining the IMF using TeV gamma ray absorption

Gamma rays of ~TeV energies from distant sources suffer attenuation due to pair production off of ~1 micron EBL photons. We may exploit this process in order to indirectly measure the EBL and constrain models of galaxy formation. Here, using semi-analytic models of galaxy formation, we examine how gamma ray absorption may be used as an indirect probe of the stellar initial mass function (IMF), although there is a degeneracy with dust modeling. We point out that with the new generation of gamma ray telescopes including STACEE, MAGIC, HESS, VERITAS, and Milagro, we should soon possess a wealth of new data and a new method for probing the nature of the IMF.Comment: contribution to "TeV Astrophysics of Extragalactic Sources" VERITAS workshop, editors M. Catanese, J. Quinn, T. Weekes; 3 pages 1 figur

Longevity risks and capital markets: The 2010-2011 update

This Special Issue of Geneva Papers on Risk and Insurance - Issues and Practice contains 10 contributions to the academic literature all dealing with longevity risk and capital markets. Draft versions of the papers were presented at Longevity Six: The Sixth International Longevity Risk and Capital Markets Solutions Conference that was held in Sydney on 9-10 September 2010. It was hosted by the Australian Institute for Population Ageing Research, the Australian School of Business and the University of New South Wales. It was sponsored by PricewaterhouseCoopers, Australian Prudential Regulation Authority (APRA), Coventry Capital, Swiss Re, and Institute of Actuaries of Australia.Longevity Risk; Capital Market

Longevity risk and capital markets: The 2009-2010 update

This Special Issue of the North American Actuarial Journal contains ten contributions to the academic literature all dealing with longevity risk and capital markets. Draft versions of the papers were presented at Longevity Five: the Fifth International Longevity Risk and Capital Markets Solutions Conference that was held in New York on 25-26 September 2009. It was hosted by J. P. Morgan and St John’s University and organized by the Pensions Institute at Cass Business School, London, and the Edmondson-Miller Chair at Illinois State University.Longevity Risk; Capital Market

Migration, trapping, and venting of gas in a soft granular material

Gas migration through a soft granular material involves a strong coupling between the motion of the gas and the deformation of the material. This process is relevant to a variety of natural phenomena, such as gas venting from sediments and gas exsolution from magma. Here, we study this process experimentally by injecting air into a quasi-2D packing of soft particles and measuring the morphology of the air as it invades and then rises due to buoyancy. We systematically increase the confining pre-stress in the packing by compressing it with a fluid-permeable piston, leading to a gradual transition in migration regime from fluidization to pathway opening to pore invasion. We find that mixed migration regimes emerge at intermediate confinement due to the spontaneous formation of a compaction layer at the top of the flow cell. By connecting these migration mechanisms with macroscopic invasion, trapping, and venting, we show that mixed regimes enable a sharp increase in the average amount of gas trapped within the packing, as well as much larger venting events. Our results suggest that the relationship between invasion, trapping, and venting could be controlled by modulating the confining stress

Detecting the Attenuation of Blazar Gamma-ray Emission by Extragalactic Background Light with GLAST

Gamma rays with energy above 10 GeV interact with optical-UV photons resulting in pair production. Therefore, a large sample of high redshift sources of these gamma rays can be used to probe the extragalactic background starlight (EBL) by examining the redshift dependence of the attenuation of the flux above 10 GeV. GLAST, the next generation high-energy gamma-ray telescope, will have the unique capability to detect thousands of gamma-ray blazars to redshifts of at least z=4, with sufficient angular resolution to allow identification of a large fraction of their optical counterparts. By combining established models of the gamma-ray blazar luminosity function, two different calculations of the high energy gamma-ray opacity due to EBL absorption, and the expected GLAST instrument performance to produce simulated fluxes and redshifts for the blazars that GLAST would detect, we demonstrate that these gamma-ray blazars have the potential to be a highly effective probe of the optical-UV EBL.Comment: 15 pages, AASTeX, 3 eps figures, accepted for publication in Ap