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Downside Risk Management of a Defined Benefit Plan Considering Longevity Basis Risk

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  • Yijia Lin
  • Ken Tan
  • Ruilin Tian
  • Jifeng Yu

Abstract

To control downside risk of a defined benefit pension plan arising from unexpected mortality improvements and severe market turbulence, this article proposes an optimization model by imposing two conditional value at risk constraints to control tail risks of pension funding status and total pension costs. With this setup, we further examine two longevity risk hedging strategies subject to basis risk. While the existing literature suggests that the excess-risk hedging strategy is more attractive than the ground-up hedging strategy as the latter is more capital intensive and expensive, our numerical examples show that the excess-risk hedging strategy is much more vulnerable to longevity basis risk, which limits its applications for pension longevity risk management. Hence, our findings provide important insight on the effect of basis risk on longevity hedging strategies.

Suggested Citation

  • Yijia Lin & Ken Tan & Ruilin Tian & Jifeng Yu, 2014. "Downside Risk Management of a Defined Benefit Plan Considering Longevity Basis Risk," North American Actuarial Journal, Taylor & Francis Journals, vol. 18(1), pages 68-86.
  • Handle: RePEc:taf:uaajxx:v:18:y:2014:i:1:p:68-86
    DOI: 10.1080/10920277.2013.852064
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    Cited by:

    1. Leng, Xuan & Peng, Liang, 2016. "Inference pitfalls in Lee–Carter model for forecasting mortality," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 58-65.
    2. Tan, Ken Seng & Weng, Chengguo & Zhang, Jinggong, 2022. "Optimal dynamic longevity hedge with basis risk," European Journal of Operational Research, Elsevier, vol. 297(1), pages 325-337.
    3. Blake, David & Cairns, Andrew J.G., 2021. "Longevity risk and capital markets: The 2019-20 update," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 395-439.
    4. Blake, David & El Karoui, Nicole & Loisel, Stéphane & MacMinn, Richard, 2018. "Longevity risk and capital markets: The 2015–16 update," Insurance: Mathematics and Economics, Elsevier, vol. 78(C), pages 157-173.
    5. Lin, Yijia & MacMinn, Richard D. & Tian, Ruilin, 2015. "De-risking defined benefit plans," Insurance: Mathematics and Economics, Elsevier, vol. 63(C), pages 52-65.
    6. Cox, Samuel H. & Lin, Yijia & Shi, Tianxiang, 2018. "Pension risk management with funding and buyout options," Insurance: Mathematics and Economics, Elsevier, vol. 78(C), pages 183-200.

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