DEFINITION of Longevity Derivatives
Longevity derivatives are a class of securities that provide a hedge against parties that are exposed to longevity risks through their businesses, such as pension plan managers and insurers. These types of derivatives are designed to have increasingly high payouts as a selected population group lives longer than was originally expected or calculated.
The first and most prevalent form of longevity derivatives is the longevity bond which is also known as survivor bond. The longevity bond pays a coupon based on the "survivorship" of a stated population group. As the mortality rate of the stated population group rises, coupon payments drop until eventually reaching zero. The longevity derivatives market has since expanded to include forward contracts, options and swaps.
BREAKING DOWN Longevity Derivatives
Speculators choose to acquire longevity derivatives from companies for several reasons. Many speculators are attracted by the fact that longevity risk has shown very low correlations with other types of investing risks, such as market risk or currency risk. Institutional investors are attracted to anything that doesn't move lockstep with equity or debt market returns.
Because they are a new class of product (the first longevity bonds were sold in the late 1990s), there are still issues being worked out as to the best way to package longevity derivatives to investors and insurer groups, how to best capture sample populations and how to use leverage most effectively.