New framework shows how to effectively hedge longevity risk.
Basis risk is important when hedging longevity risk with index-based instruments. A framework was developed to understand basis risk, calibrate hedging instruments, and evaluate hedge effectiveness. A UK case study compared assured lives with the national population, showing stable long-term relationships despite different demographics. High hedge effectiveness can be achieved with properly calibrated index-based longevity hedges. Results from a hypothetical pension portfolio and a US population support this finding.