Recent declines in life expectancy: Implication on longevity risk hedging

Abstract

An article published in the British Medical Journal in 2018 reveals that a number of developed countries have experienced a decline in life expectancy in recent years. Within the classical framework of stochastic mortality modeling, the observed decline in life expectancy may be attributed to noises around the fitted log-linear trends in age-specific death rates. However, the patterns of the mortality heat maps for these countries suggest that it is likely a result of a fading of waves of high mortality improvement, which previously contributed to a linear rise in life expectancy in the developed world. In this paper, we introduce an improved version of the heat wave mortality model, which has the potential to capture the cessation of the waves of high mortality improvement. The proposed model is then used to examine the impact of declines in life expectancy on index-based longevity hedges. It is found that if life expectancy declines, a simple delta hedge still performs reasonably well in the sense that the over-hedging problem is only modest.