The Cross‐Section of Asia‐Pacific Mortality Dynamics: Implications for Longevity Risk Sharing

• Date: 01 April 2017
• Author: Yijia Lin,Andreas Milidonis,Enrico Biffis
• DOI: http://doi.org/10.1111/jori.12194
• Published date: 01 April 2017

©2017 The Journal of Risk and Insurance. Vol.84, No. S1, 515–532 (2017).

DOI: 10.1111/jori.12194

The Cross-Section of Asia-Pacific Mortality

Dynamics: Implications for Longevity Risk Sharing

Enrico Biffis

Yijia Lin

Andreas Milidonis

Abstract

We study the dynamics of longevity risk across a subset of countries in

the Asia-Pacific (APAC) region. We use hand-collected and existing data on

age-specific mortality rates from emerging and developed economies to un-

derstand how secular changes in mortality vary within and across APAC

countries. Weuse our results to identify cross-hedging opportunities among

longevity risk exposures in the APAC region. We also introduce k-forward

contracts, which offer natural risk-sharing opportunities to hedgers in differ-

ent countries. We consider the example of Korea and Japan as a case study.

Introduction

We study the dynamics of longevity risk1across a subset of populations in the Asia-

Pacific (APAC) region. Using a new data set constructed from both hand-collected

and existing data from emerging and developing economies in APAC (see Milidonis,

2015), we conduct an extensive analysis of the balanced panel resulting from the new

data set to understand how age-specific mortality improvements vary within the

APACregion. The objective is to explore the existence of cross-hedging opportunities

among a subset of longevity risk exposures in the APAC region. We therefore also

Enrico Biffis is in the Risk Management Insurance Department at the J. Mack Robinson College

of Business, Georgia State University, 35 Broad Street, Altanta, GA 30303, and at the Finance

Department of Imperial College Business School, Imperial College London, South Kensington

Campus, London SW7 2AZ, UK. Biffis can be contacted via e-mail: e.biffis@imperial.ac.uk. Yijia

Lin is in the Department of Finance at the University of Nebraska–Lincoln, Lincoln, NE 68588-

0490. Lin can be contacted via e-mail: yijialin@unl.edu. Andreas Milidonis is in the Department

of Accounting and Finance, School of Economics and Management of the University of Cyprus,

P.O. Box 20537, CY-1678, Nicosia, Cyprus. A large part of the article was completed while he

was at the IRFRC, Nanyang Business School, NTU, Singapore. Milidonis can be contacted via e-

mail: andreas.milidonis@ucy.ac.cy. We are grateful to the Insurance Risk and Finance Research

Centre (IRFRC: www.irfrc.com)at Nanyang Business School for generous financial support and

for providing the Asia-Pacific mortality data set. Wealso thank Maria Efthymiou and Francesca

Rigoni for excellent research assistance.

1By longevity risk, we mean the risk of systematic mortality improvements.

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provide an application of longevity index design, using the Li and Lee (2005) mul-

tipopulation model (henceforth LL model) as a reference framework. The LL model

offers a compelling approach to modeling the structure of mortality improvements,

by extracting a common APAC time-series factor and a set of individual country-

specific factors modulated by age-dependent coefficients. The model performs well

in our sample relative to competing models widely used in the literature, as well

as more recent generalized dynamic factor models (GDFMs) (see Forni et al. 2005;

Alessi, Barigozzi, and Capasso, 2007; Gao and Hu, 2009; French and O’Hare, 2013).

The APAC region is important for longevity risk management for at least three rea-

sons. First, the market for longevity risk has so far revolved around pension and insur-

ance liabilities originating in Europe and North America (see, e.g., Blake et al., 2008,

2013; Lane, Clark, and Picock, 2012; Cox et al., 2013; Lin et al., 2014; Biffis et al., 2016).

Hedging solutions for defined benefit (DB) pension plans and books of annuities have

mainly taken the form of pension buy-outs, pension buy-ins, and longevity swaps2

The gradual shift from DB to defined contribution (DC) retirement plans means that

these longevity risk transfer agreements will deal by and large with “legacy” pension

assets and liabilities. The APACregion presents a different environment, as a number

of APAC countries are relatively young, and social security and pension systems are

often not very well developed. At the same time, insurance is growing strongly in the

region (see, e.g., Swiss Re 2013), and may provide natural hedging opportunities for

domestic and global (re)insurers. These include partial offsetting of longevity expo-

sures with mortality protection products (see Cox and Lin, 2007; Gatzert and Wesker,

2014), longevity-driven modulation of new business across different economies, as

well as design of longevity indices that may bring together hedgers and hedge sup-

pliers from different countries within the APAC region. This work provides some

results in this direction and explores data and statistical approaches that can help

making these concepts operational.

Second, the market for longevity risk solutions has so far been dominated by

indemnity-based products with a focus on micro longevity risk. Hedging instruments

have been structured mainly as insurance contracts indemnifying the hedger against

her own mortality experience, rather than making payments based on a reference

longevity index (see Blake, Cairns, and Dowd, 2008; Biffis et al., 2016). This repre-

sents a formidable barrier to product standardization and liquidity, which the market

is slowly trying to overcome via indexed solutions (see, e.g., Coughlan et al., 2011;

Cairns, 2013; Fetiveau and Jia, 2014) and securitization of pools of longevity exposures

(see Biffis and Blake, 2010b, 2013). The heterogeneity in APAC life expectancy trends

and age structures suggests that the region could represent an important source of

2Buy-outs entail the transfer to another institution of some or all the liabilities of a pension plan,

together with the responsibility to meet them. Buy-ins entail the purchase of bulk annuities

to insure some or all the liabilities of the pension plan, while retaining responsibility to meet

them. Bespoke longevity swaps provide floating payments linked to the mortality experience

of specific pension plans or annuity providers. Indexed swaps make floating payments linked

to the evolution of a reference index of mortality/longevity. See Biffis and Blake (2010a, 2013)

and Biffis and Kosowski (2014) for an overview.