Longevity and Mortality Derivatives

Introduction

Longevity and mortality derivatives are derivatives products which allow their users to hedge against or gain exposure to “longevity risk”, i.e. business risk relating to mortality rates or increased life expectancy in particular section of a population.

Pension funds, life insurance companies and long-term health care providers for example, use longevity derivatives to hedge against significant increased life or pension liabilities.

On the other hand, because of their low correlations with conventional risks, e.g. market or currency risk, longevity derivatives are consider good, “low beta” hedge for capital market investors.

Longevity and Mortality Indices

Often cited longevity indices include Credit Suisse's Longevity Index sub-indices for various age groups launched in early 2006 and LifeMetrics launched by JPMorgan for US, UK in March 2007 “aimed at measuring and managing longevity and mortality exposure”.

Longevity Products

Examples of longevity products include longevity or survivor bonds, forwards, options and swaps, as well as pandemic and extreme mortality covers, pension investment products. Examples include longevity annuity bonds which coupons are tied to survivorship index of “reference population”.

For example, in December 2003 Swiss Re launched its 3 years $400mm mortality bonds priced at LIBOR + 1.35% that hedged against epidemic risk or extreme mortality events in 5 countries. In many ways, it shares characteristics of a 'catastrophe bond'. Another example is the 25 years annuity “survival” bonds issued by European Investment Bank.

Future Challenges

Despite the potential, longevity derivatives have not really taken off due to a number of issues such as reliability of the data (availability and time horizons), lack of consistent stochastic models, high cost and not enough takers of the mortality risk. There have been efforts to lobby national governments to boost the longevity market by issuance of government longevity bonds which would help to set the risk-free reference for longevity risk.

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Last updated April 2008

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