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Hedging Longevity Risk in Life Settlements Using Biomedical Research‐Backed Obligations

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Journal of Risk & Insurance

Published online on

Abstract

In the life settlement market, mortality risk is transferred from life insurance policyholders to third‐party life settlement firms. This risk transfer occurs in conjunction with an information transfer that is relevant not only for pricing, but also for risk management. In this analysis, we compare the efficiency of two different hedging instruments in managing the mortality risk of the life settlement firm. First, we claim and then demonstrate that conventional longevity‐linked securities do not perform as effectively in the secondary life market, that is, life settlement market, as in the annuity and pension markets due to the basis risk that exists between the general population and the life settlement subgroup. Second, we show that the unique risk exposure of the life settlement firm can be specifically targeted using a new instrument—the biomedical research‐backed obligations. Our finding connects two seemingly independent markets and can promote the healthy development of both.