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Longevity basis risk research underway

Dan Purves




Research into longevity basis risk is underway to help develop a life market, led by Macquarie University and supported by University Waterloo (Ontario, Canada), Australian National University and Mercer Australia.

There is huge potential to pass on some of the risks associated with longevity to the capital markets, through the use of market tools such as longevity bonds, longevity swaps, longevity futures, forwards, and options that are similar to those in the existing financial markets, said Associate Professor Jacki Li from Macquarie University.

“From what it appears it is not correlated with traditional asset classes. For example, it would be hard to imagine how gold prices would be correlated with longevity within the next 10 years,” Li said.

However, to hedge longevity risk these market tools will need to be structured around an index, and no such one yet exists for longevity.

“The problem is they don’t know how to measure the basis risk, so institutional investors are not comfortable about using these type of tools.

“So we are developing a practical and also theoretically sound method to measure the basis risk, then the insurers and super funds would feel more comfortable.”

The research is building on a project in 2013/14 that developed a methodology for insurers and pension schemes to assess longevity risk.

“One of the factors that has stopped the development of a life market is that developers have not found a way to hedge the risk,” Li said, adding that the lack of choice in the market has caused many products that tackled longevity risk, such as annuities, to be expensive.

“The LLMA (Life and Longevity Markets Association) think this is the key to unlock the market. If we can measure the basis risk, then people can find a way to hedge the risk, more products will come up [and] it will be beneficial to the public in terms of having more products.”

The project is funded by the UK Institute and Faculty of Actuaries (IFoA) and the Life and Longevity Markets Association (LLMA), with result due to be published in April or May next year.