Sharing of longevity basis risk in pension schemes with income-drawdown guarantees

Ankush Agarwal, Christian-Oliver Ewald and Yongjie Wang

Working Papers from Business School - Economics, University of Glasgow

Abstract: This work studies a stochastic control problem for a pension scheme which provides an income-drawdown policy. The manager and members agree to share the investment risk based on a risk-sharing rule. The objective is to maximise both sides’ utilities by controlling the investment strategy and benefit withdrawals. We use stochastic affine class models to describe the force of mortality and consider a longevity bond whose coupon payment is linked to a survival index. We also investigate the longevity basis risk, which arises when the members’ and the longevity bond’s reference populations correlate imperfectly. By applying the dynamic programming principle to solve the corresponding HJB equations, we derive optimal solutions for the single and sub-population cases. Our numerical results show that both manager and members benefit from sharing the risk. Moreover, even in the presence of longevity basis risk, we demonstrate that the longevity bond acts as an effective hedging instrument.

Keywords: Pension scheme; longevity basis risk; mortality-linked instrument; stochastic control; dynamic programming principle (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-age, nep-ore and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Sharing of longevity basis risk in pension schemes with income-drawdown guarantees (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2020_18

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