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

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

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

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

The Securitization of Longevity Risk and its Implications for Retirement Security

The economic significance of longevity risk for governments, corporations, and individuals has begun to be recognized and quantified. The traditional insurance route for managing this risk has serious limitations due to capacity constraints that are becoming more and more binding. If the 2010 U.S. population lived three years longer than expected then the government would have to set aside 50% of the U.S. 2010 GDP or approximately $7.37 trillion to fully fund that increased social security liability. This is just one way of gauging the size of the risk. Due to the much larger capacity of capital markets more attention is being devoted to transforming longevity risk from its pure risk form to a speculative risk form so that it can be traded in the capital markets. This transformation has implications for governments, corporations and individuals that will be explored here. The analysis will view the management of longevity risk by considering how defined contribution plans can be managed to increase the sustainable length of retirement and by considering how defined benefit plans can be managed to reduce pension risk using longevity risk hedging schemes

Episodic fluid venting from sedimentary basins fuelled by pressurised mudstones

Subsurface sandstone reservoirs sealed by overlying, low-permeability layers provide capacity for long-term sequestration of anthropogenic waste. Leakage can occur if reservoir pressures rise sufficiently to fracture the seal. Such pressures can be generated within the reservoir by vigorous injection of waste or, over thousands of years, by natural processes. In either case, the precise role of intercalated mudstones in the long-term evolution of reservoir pressure remains unclear; these layers have variously been viewed as seals, as pressure sinks or as pressure sources. Here, we use the geological record of episodic fluid venting in the Levant Basin to provide striking evidence for the pressure-source hypothesis. We use a Bayesian framework to combine recently published venting data, which record critical subsurface pressures since $\sim$2 Ma, with a stochastic model of pressure evolution to infer a pressure-recharge rate of $\sim$30 MPa/Myr. To explain this large rate, we quantify and compare a range of candidate mechanisms. We find that poroelastic pressure diffusion from mudstones provides the most plausible explanation for these observations, amplifying the $\sim$1 MPa/Myr recharge caused by tectonic compression. Since pressurised mudstones are ubiquitous in sedimentary basins, pressure diffusion from mudstones is likely to promote seal failure globally

Episodic, compression-driven fluid venting in layered sedimentary basins

Fluid venting phenomena are prevalent in sedimentary basins globally. Offshore, these localised fluid-expulsion events are archived in the geologic record via the resulting pockmarks at the sea-floor. Venting is widely interpreted to occur via hydraulic fracturing, which requires near-lithostatic pore pressures for initiation. One common driver for these extreme pressures is horizontal tectonic compression, which pressurises the entire sedimentary column over a wide region. Fluid expulsion leads to a sudden, local relief of this pressure, which then gradually recharges through continued compression, leading to episodic venting. Pressure recharge will also occur through pressure diffusion from neighboring regions that remain pressurised, but the combined role of compression and pressure diffusion in episodic venting has not previously been considered. Here, we develop a novel poroelastic model for episodic, compression-driven venting. We show that compression and pressure diffusion together set the resulting venting period. We derive a simple analytical expression for this venting period, demonstrating that pressure diffusion can significantly reduce the venting period associated with a given rate of compression and allowing this rate of compression to be inferred from observations of episodic venting. Our results indicate that pressure diffusion is a major contributor to episodic fluid venting in mudstone-dominated basins

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