The Hedging Effectiveness of Mortality and Longevity Risks Mitigation

Abstract

Hedging is one of alternative method for life insurance companies and annuities providers (pension funds) to manage mortality and longevity risk. Hedging strategy is done by buying a mortality-linked securities from financial intermediaries. The optimal unit of mortality-linked securities that maximize the effectiveness of hedging is derived through the closed form solution of the hedging scheme. Mortality model used in this hedging schemes is Lee-Carter model. Forecasting method of Lee-Carter becomes one of the most well-known and has been successfully applied in many countries to predict the mortality rate of the population. Empirical test was done using Chilean population data. The implementation resulted in a 74% level of hedging effectiveness against mortality risk and 72% to longevity risk.