Pricing Longevity Bonds under a Credibility Framework with Limited Available Data

Abstract

For annuity providers, a higher life expectancy is not always positive news, as it potentially implies increased future costs, since benefits must be provided over a longer period of time. The underlying risk behind the unexpected improvement in life expectancy is called longevity risk. One way to hedge this risk can be attained with the process of securitization through mortality risk securities. This process requires an accurate prediction of the future mortality dynamics with an appropriate mortality model. However, a major issue in mortality modeling is the limited number of available data for a given population. The purpose of this paper is to present a mortality model under the credibility regression framework, aiming to capture the future mortality trends, especially for population datasets of limited available observations. Then, we show how this approach can be incorporated into pricing longevity bonds with the Wang transform. To ensure transparency and applicability in our illustration, the longevity bond pricing is based on the mortality data of Greece.