A Cautionary Note on Natural Hedging of Longevity Risk

Nan Zhu, Daniel Bauer

Research output: Contribution to journalArticle

9 Scopus citations

Abstract

In this article, we examine the so-called natural hedging approach for life insurers to internally manage their longevity risk exposure by adjusting their insurance portfolio. In particular, unlike the existing literature, we also consider a nonparametric mortality forecasting model that avoids the assumption that all mortality rates are driven by the same factor(s). Our primary finding is that higher order variations in mortality rates may considerably affect the performance of natural hedging. More precisely, although results based on a parametric single factor model-in line with the existing literature-imply that almost all longevity risk can be hedged, results are far less encouraging for the nonparametric mortality model. Our finding is supported by robustness tests based on alternative mortality models.

Original languageEnglish (US)
Pages (from-to)104-115
Number of pages12
JournalNorth American Actuarial Journal
Volume18
Issue number1
DOIs
StatePublished - Jan 2014

All Science Journal Classification (ASJC) codes

  • Statistics and Probability
  • Economics and Econometrics
  • Statistics, Probability and Uncertainty

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