Hedging Longevity Risk When Interest Rates are Uncertain

Abstract

This paper proposes an asset liability management strategy to hedge the aggregate risk of annuity providers under the assumption that both the interest rate and mortality rate are stochastic. We assume that annuity providers can invest in longevity bonds, long-term coupon bonds, and shortterm zero-coupon bonds to immunize themselves from the risks of the annuity for the equity holders subject to a required profit. We demonstrate that the optimal allocation strategy can lead to the lowest risk under different yield curves and mortality rate assumptions. The longevity bond can also be regarded as an effective hedging vehicle that significantly reduces the aggregate risk of the annuity providers.