Hedging Longevity Risk

Longevity risk, i.e. people living longer than expected, is getting more important for pension funds and insurance companies. Although longevity risk is traditionally viewed as unhedgeable, a market for mortality-linked derivatives is developing since the early 2000s. In this thesis I forecast mortality rates with the well-known Lee-Carter model. With these forecasts I price longevity index swaps using Monte Carlo simulations and the equivalent utility pricing principle. In order to hedge against longevity risk with the longevity index swaps I use a static approach. I analyse in what matter hedging longevity risk influences a stylised market value balance sheet for Nationale-Nederlanden under the Solvency II regulations. I find that the solvency capital requirements and the risk margin on the market value balance sheet decrease if longevity risk is hedged. The hedging costs involved are lower than the decrease in liabilities, i.e. longevity index swaps provide a profitable opportunity for hedging longevity risk.