Collateral

Longevity Swaps are increasingly employed by longevity stakeholders (such as pension funds and life offices) as a means for removing for longevity risk.

 

These essentially work through an exchange of liability cash flows where the hedger pays "fixed" cashflows based on agreed, static mortality asumptions and receives "floating" cashflows based on actual survivorship of the membership in question. 

 

Both parties to a longevity swap run credit risk in respect of their counterparty's primary obligations.  As such, these arrangements are often collateralised to offer credit support for these obligations.   

 

Collateral is based upon the capitalised value of the difference between the future "fixed" cashflows and future "floating" cashflows.

 

Given no objective, observable market for longevity, the present value of future "floating" cashflows is generally only updated from time to time when either party calls for a review of the prevailing "best estimate" of future survivorship.

 

One issue with such "best estimates" is that, if they are made using the current framework widely adopted by actuaries, they can significantly delay recognition of certain longevity drivers.  This can fundamentally affect cover for hedgers of longevity via such means.     

© 2012 by CONSULTING SOLUTIONS. All rights reserved

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