The Impact of Collateralization on Longevity Swap Transactions

Selin Özen, Şule Şahin

Research output: Chapter in Book/Report/Conference proceedingChapter


Index-based longevity swaps provide many advantages over
the other hedging instruments to life insurance companies and pension
plans. Insurers and pension plan providers can transfer their longevity
exposures to the capital markets at lower costs by using these securities.
Hence, significant growth has been seen in longevity swap transactions in
the longevity-linked securities and derivatives markets since 2008. However, since longevity-linked instruments are traded OTC, each involved
party is exposed to the counterparty default risk. Therefore, regulators
have emphasised the role of credit risk mitigation tools such as collateralization for the improvement of swap contracts’ credit quality. In this
paper, our aim is to construct a hedging strategy for longevity risk by using
collateral. As the first step, the Lee-Carter with renewal process and exponential jumps model proposed by Ozen and Sahin [7] and the Lee-Carter
model without jumps are used to project the future mortality rates and to
price the index-based longevity swaps. Additionally, re-hypothecation is
allowed for the parties of the swap to increase the benefits of the collateralization. As a result, for both mortality models, insurers and pension plan
providers obtain more effective risk reduction levels with the inclusion of
the collateral. However, the Lee-Carter model with renewal process and
exponential jump model provides more risk reduction.
Original languageEnglish
Title of host publicationMathematical and Statistical Methods for Actuarial Science and Finance, MAF 2022
EditorsMarco Corazza, Cira Perna, Claudio Pizzi, Marilena Sibillo
PublisherSpringer Press
Number of pages6
Publication statusPublished - 5 Apr 2022

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