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On the effectiveness of natural hedging for insurance companies and pension plans

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  • Li, Jackie
  • Haberman, Steven

Abstract

Natural hedging is one possible method to reduce longevity risk exposure for an annuity provider or a pension plan. In this paper, we provide an assessment of the effectiveness of natural hedging between annuity and life products, using the correlated Poisson Lee–Carter model, Poisson common factor model, product-ratio model, and historical simulation. Our analysis is based on the mortality experience of UK assured lives, pensioners, and annuitants, and the national population of England and Wales. We consider a range of different scenarios, and find that the level of risk reduction is significant in general, with an average of around 60%. These results have important implications for those insurers, reinsurers, and pension plan sponsors who are seeking ways to hedge their unwanted risk exposures.

Suggested Citation

  • Li, Jackie & Haberman, Steven, 2015. "On the effectiveness of natural hedging for insurance companies and pension plans," Insurance: Mathematics and Economics, Elsevier, vol. 61(C), pages 286-297.
    • Handle: RePEc:eee:insuma:v:61:y:2015:i:c:p:286-297
    DOI: 10.1016/j.insmatheco.2015.01.009
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    Cited by:

    1. Uditha Balasooriya & Johnny Siu-Hang Li & Jackie Li, 2020. "The Impact of Model Uncertainty on Index-Based Longevity Hedging and Measurement of Longevity Basis Risk," Risks, MDPI, vol. 8(3), pages 1-27, August.
    2. Boonen, Tim J. & De Waegenaere, Anja & Norde, Henk, 2017. "Redistribution of longevity risk: The effect of heterogeneous mortality beliefs," Insurance: Mathematics and Economics, Elsevier, vol. 72(C), pages 175-188.
    3. de Jong, Piet & Tickle, Leonie & Xu, Jianhui, 2016. "Coherent modeling of male and female mortality using Lee–Carter in a complex number framework," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 130-137.
    4. Jackie Li & Leonie Tickle & Nick Parr, 2016. "A multi-population evaluation of the Poisson common factor model for projecting mortality jointly for both sexes," Journal of Population Research, Springer, vol. 33(4), pages 333-360, December.
    5. Kenneth Wong & Jackie Li & Sixian Tang, 2020. "A modified common factor model for modelling mortality jointly for both sexes," Journal of Population Research, Springer, vol. 37(2), pages 181-212, June.

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