Dynamic Longevity Hedging in the Presence of Population Basis Risk: A Feasibility Analysis from Technical and Economic Perspectives

In this paper, we study the feasibility of dynamic longevity hedging with standardized securities that are linked to broad-based mortality indexes. On the technical front, we generalize the dynamic `delta' hedging strategy developed by Cairns (2011) to incorporate the situation when the populations associated with the hedger's portfolio and the hedging instruments are di_erent.

Our empirical results indicate that dynamic hedging can e_ectively reduce the longevity exposure of a typical pension plan, even if population basis risk is taken into account. On the economic front, we investigate the potential _nancial bene_ts of adynamic index-based hedge over a bespoke risk transfer. By considering data from a large group of national populations, we found evidence supporting the diversi_ability of population basis risk. It follows that for hedgers who intend to completely eliminate their longevity risk exposures, it may be more economical to hedge the underlying trend risk with a dynamic index-based hedge and transfer the residual basis risk through a reinsurance mechanism.