Longevity Derivatives

Pension funds and insurance companies have typically used insurance and reinsurance to deal with longevity risk. However, the scope of worldwide longevity risk is estimated to be in excess of $20 trillion--an amount that is likely well in excess of insurance industry capacity. As a result, there has recently been a growing market in longevity derivatives. Longevity-related derivatives such as swaps and forwards tap into the vast capacity of the broader capital markets. Longevity derivatives are simply financial contracts used by entities such as pension funds to protect themselves against longevity risk or the unexpected risk of plan members living longer than expected. By using longevity derivatives, pension plans or insurance companies pass-on the longevity risk to professional investors. The investor promises to pay some or all of the liabilities that arise from a funding shortfall if retirees live longer than predicted, in return for receiving some assets from a counter party such as a pension fund.