Cass Business School, part of City University London, and Hymans Robertson have made a successful bid for a Longevity Basis Risk Quantification research project for the Longevity Basis Risk Working Group (LBRWG).
The project is funded by the Institute and Faculty of Actuaries (IFoA) and the Life and Longevity Markets Association (LLMA) which founded the LBRWG in 2012.
An important problem facing insurance companies and pension schemes is the measurement of the basis risk arising from the use of population-based mortality indices for managing the longevity risk inherent in specific blocks of pension benefits or annuitant liabilities.
Cass and Hymans Robertson will aim to develop a readily-applicable methodology to quantify this basis risk.
The LLMA began publishing indices linked to population mortality statistics in March 2012 with the goal of facilitating the hedging of longevity risk for pension funds and annuity books.
The launch of the LLMA indices was an important milestone towards a longevity market where risk management can be carried out through transactions that are linked to standardised population-level data.
Index-based hedges have considerable potential to provide effective risk and capital management for all holders of longevity risk.
In addition to the mortality indices, the LLMA has also produced a significant body of work around possible derivative transactions that could reference mortality indices and offer standardised longevity risk management tools.
Sarah Mathieson, head of research at the IFoA, says: "In the context of a longevity hedge, longevity basis risk is the potential mismatch between the behaviour of the longevity hedge and the portfolio of pensioners or annuitants being hedged, when the hedge has been based on a generic mortality index rather than the actual pool of lives in the pension scheme or annuity book. This project aims to develop a methodology to quantify the risk, which we believe will benefit a range of parties involved in pensions, from scheme sponsors to scheme members, as well as writers of annuity business."
Dan Ryan spokesperson for the LLMA, says: “With the help of Cass and Hymans Robertson, the Life and Longevity Markets Association believes that this project will go a long way to develop market clarity and support our brief to grow this marketplace. The resulting research will hopefully bring a real and quantifiable solution to the issue of longevity risk.”
Lead researcher and Cass Dean Professor Steven Haberman says: “This project offers us a great opportunity to bring together the School’s strengths – academic excellence and practical industry knowledge. We will be using statistical knowledge and original research to produce a solution to a real industry problem. We look forward to working closely with our partners Hymans Robertson on this project.”
Andrew Gaches, partner at Hymans Robertson, says: “Pension schemes are increasingly looking to reduce their exposure to longevity risk and are demanding solutions which complement their existing use of bespoke longevity swaps. Index-based solutions are a promising approach. But to use them, schemes need a way of assessing the ‘basis risk’ – how well mortality-based population indices will match a scheme’s specific portfolio of members.
“We are excited about working with Cass Business School to create a new, practical methodology that will help pension schemes and insurers assess the benefits of index-based longevity solutions, and enable them to make the best decisions for managing longevity risk.”