Hedging the longevity risk for the portuguese population in the bond market

Abstract

Increases in life expectancy have been noticeable in recent decades and this is one of the key issues to the annuities industry and to the public pensions system. To address the problem of hedging the longevity risk, several instruments have been discussed within the financial markets in order to find a solution. Many stochastic models have been suggested to fit the evolution of the mortality curve as close as possible, so that these financial instruments can be issued on a solid basis. In this paper, we discuss and simulate the issue of two longevity bonds with cash flows linked to the evolution of a survival index, built on the Portuguese mortality data. The forecast of mortality rates is per- formed using a two-factor stochastic model, the Cairns-Blake-Dowd (CBD) model. The main objective is to develop a hedging solution to the increases in human longevity in Portugal.