It Takes Two: Why Mortality Trend Modeling is more than modeling one Mortality Trend

Similar documents
HEDGING LONGEVITY RISK: A FORENSIC, MODEL-BASED ANALYSIS AND DECOMPOSITION OF BASIS RISK

A Set of new Stochastic Trend Models

Longevity Seminar. Forward Mortality Rates. Presenter(s): Andrew Hunt. Sponsored by

Hedging Longevity Risk using Longevity Swaps: A Case Study of the Social Security and National Insurance Trust (SSNIT), Ghana

Longevity risk and stochastic models

Evaluating Hedge Effectiveness for Longevity Annuities

September 7th, 2009 Dr. Guido Grützner 1

Time-Simultaneous Fan Charts: Applications to Stochastic Life Table Forecasting

An alternative approach for the key assumption of life insurers and pension funds

Modeling the Mortality Trend under Modern Solvency Regimes

Modelling Longevity Dynamics for Pensions and Annuity Business

MODELLING AND MANAGEMENT OF LONGEVITY RISK. Andrew Cairns Heriot-Watt University, and The Maxwell Institute, Edinburgh

MODELLING AND MANAGEMENT OF MORTALITY RISK

Pricing death. or Modelling the Mortality Term Structure. Andrew Cairns Heriot-Watt University, Edinburgh. Joint work with David Blake & Kevin Dowd

Forward mortality rates. Actuarial Research Conference 15July2014 Andrew Hunt

Our New Old Problem Pricing Longevity Risk in Australia. Patricia Berry, Lawrence Tsui (& Gavin Jones) < copyright Berry, Tsui, Jones>

Tools for testing the Solvency Capital Requirement for life insurance. Mariarosaria Coppola 1, Valeria D Amato 2

IFRS Convergence: The Role of Stochastic Mortality Models in the Disclosure of Longevity Risk for Defined Benefit Plans

A new approach to multiple curve Market Models of Interest Rates. Rodney Hoskinson

Accounting and Actuarial Smoothing of Retirement Payouts in Participating Life Annuities

The CMI Mortality Projections Model

MORTALITY RISK ASSESSMENT UNDER IFRS 17

Coherent Capital Framework for Longevity Risk

A Simple Stochastic Model for Longevity Risk revisited through Bootstrap

Modeling and Managing Longevity Risk: Models and Applications

Constructing Two-Dimensional Mortality Improvement Scales for Canadian Pension Plans and Insurers: A Stochastic Modelling Approach

Longevity hedge effectiveness Cairns, Andrew John George; Dowd, Kevin; Blake, David; Coughlan, Guy D

ROBUST HEDGING OF LONGEVITY RISK. Andrew Cairns Heriot-Watt University, and The Maxwell Institute, Edinburgh

Multi-year non-life insurance risk of dependent lines of business

COUNTRY REPORT TURKEY

Risk analysis of annuity conversion options in a stochastic mortality environment

Anticipating the new life market:

DISCUSSION PAPER PI-0801

DATE SUBMITTED 2009/06/10. 1 ST AUTHOR LAST NAME Rozar. 1 ST AUTHOR FIRST NAME Timothy L

Forecasting Real Estate Prices

Understanding, Measuring & Managing Longevity Risk. Longevity Modelling Technical Paper

Optimal Portfolio Choice in Retirement with Participating Life Annuities

Retirement Saving, Annuity Markets, and Lifecycle Modeling. James Poterba 10 July 2008

Reserving Risk and Solvency II

Sharing Longevity Risk: Why governments should issue Longevity Bonds

Modeling Mortality Trend under Modern Solvency Regimes

The Impact of Natural Hedging on a Life Insurer s Risk Situation

MORTALITY IS ALIVE AND KICKING. Stochastic Mortality Modelling

Annuities: Why they are so important and why they are so difficult to provide

IIntroduction the framework

HEDGING THE LONGEVITY RISK FOR THE PORTUGUESE POPULATION IN THE BOND MARKET

A comparative study of two-population models for the assessment of basis risk in longevity hedges

Robust Longevity Risk Management

Session 6A, Mortality Improvement Approaches. Moderator: Jean Marc Fix, FSA, MAAA. Presenters: Laurence Pinzur, FSA

Risk analysis of annuity conversion options with a special focus on decomposing risk

Reserve Risk Modelling: Theoretical and Practical Aspects

Subject CS2A Risk Modelling and Survival Analysis Core Principles

DISCUSSION PAPER PI-1015

The Extended Exogenous Maturity Vintage Model Across the Consumer Credit Lifecycle

Comparison of Pricing Approaches for Longevity Markets

Prepared by Ralph Stevens. Presented to the Institute of Actuaries of Australia Biennial Convention April 2011 Sydney

Modelling, Estimation and Hedging of Longevity Risk

Mortality Density Forecasts: An Analysis of Six Stochastic Mortality Models

Fast Convergence of Regress-later Series Estimators

DB Quant Research Americas

The implications of mortality heterogeneity on longevity sharing retirement income products

Cypriot Mortality and Pension Benefits

Understanding Differential Cycle Sensitivity for Loan Portfolios

Asymmetric Information in Secondary Insurance Markets: Evidence from the Life Settlement Market

A GENERALISATION OF THE SMITH-OLIVIER MODEL FOR STOCHASTIC MORTALITY

Mortality Improvement Rates: Modelling and Parameter Uncertainty

Basis risk in solvency capital requirements for longevity risk

Evidence from Large Indemnity and Medical Triangles

The CMI Mortality Projections Model Fri 13 th November 2009

Market Risk Analysis Volume II. Practical Financial Econometrics

Pricing q-forward Contracts: An evaluation of estimation window and pricing method under different mortality models

Modeling multi-state health transitions in China: A generalized linear model with time trends

UNISEX PRICING OF GERMAN PARTICIPATING LIFE ANNUITIES BOON OR BANE FOR POLICYHOLDER AND INSURANCE COMPANY?

Annuity Decisions with Systematic Longevity Risk. Ralph Stevens

SOA Annual Symposium Shanghai. November 5-6, Shanghai, China

Immunization and Hedging of Longevity Risk

Accounting-based Asset Return Smoothing in Participating Life Annuities: Implications for Annuitants, Insurers, and Policymakers

Market Risk Analysis Volume I

DISCUSSION PAPER PI-1109

Consistently modeling unisex mortality rates. Dr. Peter Hieber, Longevity 14, University of Ulm, Germany

Quebec Pension Plan (QPP) multi-population data analysis

Comments on: A. Armstrong, N. Draper, and E. Westerhout, The impact of demographic uncertainty on public finances in the Netherlands

A user-friendly approach to stochastic mortality modelling

Model To Develop A Provision For Adverse Deviation (PAD) For The Longevity Risk for Impaired Lives. Sudath Ranasinghe University of Connecticut

Sharing longevity risk: Why Governments should issue longevity bonds

Stochastic Modelling: The power behind effective financial planning. Better Outcomes For All. Good for the consumer. Good for the Industry.

Paper Review Hawkes Process: Fast Calibration, Application to Trade Clustering, and Diffusive Limit by Jose da Fonseca and Riadh Zaatour

This homework assignment uses the material on pages ( A moving average ).

The Risk of Model Misspecification and its Impact on Solvency Measurement in the Insurance Sector

Evidence from Large Workers

Longevity Risk Mitigation in Pension Design To Share or to Transfer

Advanced Quantitative Methods for Asset Pricing and Structuring

Pricing and Risk Management of guarantees in unit-linked life insurance

A Cautionary Note on Natural Hedging of Longevity Risk

Medical Underwriting and Valuation in the Life Settlements Market

City, University of London Institutional Repository. This version of the publication may differ from the final published version.

Guaranteed Minimum Surrender Benefits and Variable Annuities: The Impact of Regulator- Imposed Guarantees

Recreating Sustainable Retirement

Occasional Paper. Dynamic Methods for Analyzing Hedge-Fund Performance: A Note Using Texas Energy-Related Funds. Jiaqi Chen and Michael L.

An Analysis of Pricing and Risks. of Reverse Mortgage Loans and. Long-Term Care Insurance

Transcription:

It Takes Two: Why Mortality Trend Modeling is more than modeling one Mortality Trend Johannes Schupp Joint work with Matthias Börger and Jochen Russ IAA Life Section Colloquium, Barcelona, 23 th -24 th October 2017 www.ifa-ulm.de

Introduction Uncertainty about the evolution of mortality Decrease in mortality rates and increase in life expectancy Similar patterns for most countries Increasing attention on longevity risk Measure longevity risk in pension or annuity portfolios with stochastic mortality models Parametric mortality models: Lee-Carter model, Cairns-Blake-Dowd model, APC model, etc. Estimate the current speed of improvements in mortality Stochastic forecasts of future mortality 2 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Introduction Two parameter processes (Cairns et al. (2006)) log qq xx,tt 1 qq xx,tt = κκ 1 tt + κκ 2 tt xx xx Parameter processes calibrated for English and Welsh males older than 65 years In principle, our approach can be applied to any parametric mortality model Popular choice: a (multivariate) random walk with drift for stochastic forecasts Historic trend changed once in a while Only a piecewise linear trend with random changes in the trends slope Random fluctuation around the prevailing trend Extrapolating only the most recent trend, systematically underestimates future uncertainty, see e.g. Sweeting (2011), Li et al. (2011), Börger et al. (2014) 3 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Introduction We don t know the current mortality trend for sure But the estimate for the current trend seems a good best estimate for the future evolution Possible future changes of the trend in both directions One model for the actual mortality trend One model for the estimation of the current trend at some point in time, that is the estimated mortality trend In many situations, both components are necessary 4 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Agenda Why two mortality trends? Actual mortality trend (AMT) Estimated mortality trend (EMT) Some examples A combined model for AMT & EMT AMT component EMT component Conclusion 5 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Why two mortality trends? Actual Mortality Trend (AMT) The AMT describes realized mortality trends Core of most existing mortality models Time and magnitude of changes in the AMT and the error structure around the trend process need to be modeled We have an idea of the historic AMT but it s not fully observable! We can t always distinguish between a recent trend change and normal random fluctuation around the prevailing trend possible undetected trend change in the recent years Unknown current value of the AMT and unknown current value of the trend process 6 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Why two mortality trends? Estimated Mortality Trend (EMT) The EMT describes actuary s/demographers expectation about the AMT, i.e. the current slope of the mortality trend at some point in time Based on most recent historical, observed mortality evolution and updated as soon as new observations become available The EMT is the basis for mortality projections, (generational) mortality tables, reserves, etc. 7 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Why two mortality trends? Some examples Why another trend? Requirement for AMT and/or EMT depends on application: Reserves for a portfolio EMT today Capital for a portfolio run-off AMT over the run-off Reserves for a portfolio after 10 years AMT over the 10 years, EMT after 10 years Payout of a mortality derivative AMT up to maturity, EMT at maturity Analyse the hedge effectiveness of the previous derivative EMT at maturity, AMT beyond 8 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

A Combined model for AMT/EMT AMT component Continuous piecewise linear trend, with random changes in the slope and random fluctuation around the trend AMT model specification: Model the trend process with random noise κκ tt = κκ tt + εε tt ; εε tt ~NN(0, σσ 2 εε ) Extrapolate the most recent actual mortality trend κκ tt = κκ tt 1 + AAAAAA tt In every year, there is a possible change in the mortality trend with probability pp AAAAAA AAAAAA tt = tt 1 wwwwwww pppppppppppppppppppppp 1 pp AAAAAA tt 1 + λλ tt wwwwwww pppppppppppppppppppppp pp In the case of a trend change λλ tt = MM tt SS tt With absolute magnitude of the trend change MM tt ~LNN(μμ, σσ 2 ) Sign of the trend change SS tt bernoulli distributed with values -1, 1 each with probability 1 2 Parameters to be estimated for projections: pp, σσ 2 εε, μμ, σσ 2, AAAAAA nn, κκ nn 9 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

A Combined model for AMT/EMT AMT component Idea: Use historic trends to estimate the parameters pp, σσ 2 εε, μμ, σσ 2, AAAATT nn, κκ nn For details on the calibration we refer to Börger and Schupp (2015) and Schupp (2017). Parameter uncertainty is included. See Appendix for a comparison with other AMT approaches. 10 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

A Combined model for AMT/EMT EMT component We see random changes in the future AMT according to the symmetric density function of the trend change intensity (λλ ii = MM ii SS ii in each year ii with a trend change) Symmetric density function of future AAAATT ss, ss > tt with mean AAAATT tt EE AAAATT ss = AAAATT tt, ss > tt arbitrary Choose EMMTT tt as the expected AAAATT tt given realized mortality up to this point in time EEEETT tt = EE AAAATT tt Difficult in a simulation, as the path-dependent calculation of the EEMMTT tt is complex (see Börger and Schupp (2015)). In each path the complete trend process needs to be recalibrated Possible, but not feasible from a practical point of view Piecewise linear trend process with symmetric changes in the AMT Calibrate the EMT with a linear regression on most recent data 11 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

A Combined model for AMT/EMT EMT component Higher influence of most recent data in the estimation of the regression Weighted regression in year s: ww ii ss, tt = 1 (1 + 1 ) ss tt h ii for both parameter processes ii = 1,2 and tt ss Other possible methods: Linear regression with data from the last 5/10/20 years (in the spirit of Cairns et al. (2014)) How many years should be included in the regression? Too many delayed reaction of EMT on trend changes in the AMT Too little EMT is vulnerable to random noise in the AMT 12 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

A Combined model for AMT/EMT EMT component Calibration of the weights based on a practical application Consider a portfolio of 45 year old males. Calculate the required reserves when the portfolio retires (at age 65). Fixed interest rate of 2%. Calibrate the AMT model for 65 year old males (England and Wales) Simulate the future evolution of the AMT 100.000 times with annual errors for each path After 20 years, calculate the reserves with the EMT for each path Further simulate the AMT and compare the realized capital requirement with the reserves based on the EMT Optimal weighting (h 1, h 2 ) can be determined by minimizing the MSE between reserves and realized capital requirement 13 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Combined AMT/EMT Model EMT component - comparison Calibration of the EMT components - comparison Unique solution: (h 1 = 3,6, h 2 = 1,4) Estimated present value of portfolio vs. realized present value EMT estimation method MSE Root MSE Optimal weighting 0.3216 0.5671 Optimal weighting (+0.5) 0.3261 0.5710 Optimal weighting (-0.5) 0.3259 0.5708 Regression last 5 years 1.026 1.0131 Regression last 10 years 0.3608 0.6007 Regression last 20 years 0.3794 0.6160 The risk of a false estimation of the reserves based on future mortality can be minimized with the optimal weighting EMT approach 14 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Combined AMT/EMT Model EMT component Calibration of the EMT components - comparison Practical implication: Underestimation of reserves is critical EMT approach has a crucial impact on the capital adequacy of reserves EMT estimation method >5% underestimation >10% underestimation Optimal weighting 3.6% 0.4% Regression last 5 years 13.8% 1.5% Use optimal weighting EMT approach instead of a linear regression on the last 5 years The probability of underestimating the required reserves by more than 5% can be reduced from 13.8% to 3.6% The probability of underestimating the required reserves by more than 10% can be reduced from 1.5% to 0.4% 15 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Conclusion Two trends need to be distinguished and modeled The actual mortality trend (AMT) is the prevailing, unobservable mortality trend The estimated mortality trend (EMT) is the estimate of the AMT The trend to consider depends on the question in view The AMT is modeled as a continuous and piecewise linear trend with random changes in the trend s slope The random walk with drift underestimates the longevity risk systematically Based on the AMT model we can estimate an appropriate time period for the estimation of a deterministic trend Choice of EMT approach is crucial in many practical situations A weighted regression approach seems reasonable Optimal regression weights can be determined in a practical setting 16 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Literature Börger, M., Fleischer, D., Kuksin, N., 2014. Modeling Mortality Trend under Modern Solvency Regimes. ASTIN Bulletin, 44: 1 38. Börger, M., Schupp, J., 2015. Modeling Trend Processes in Parametric Mortality. Working Paper, Ulm University. Cairns, A., Blake, D., Dowd, K., 2006. A Two-Factor Model for Stochastic Mortality with Parameter Uncertainty: Theory and Calibration. Journal of Risk and Insurance, 73: 687 718. Cairns, A. J. G., Dowd, K., Blake, D. & Coughlan, G. D. (2014). Longevity hedge effectiveness: A decomposition. Quantitative Finance, 14(2), 217-235. Chan, W.-S., Li, J. S.-H., and Li, J. (2014). The CBD mortality indexes: modeling and applications. North American Actuarial Journal, 18(1): 38 58. Hunt, A. and Blake, D. (2014). Consistent mortality projections allowing for trend changes and cohort effects. Working Paper, Cass Business School Li, J. S.-H., Chan, W.-S., and Cheung, S.-H. (2011). Structural changes in the Lee-Carter indexes: detection and implications. North American Actuarial Journal, 15(1): 13 31. Schupp, J., 2017. A Set of new Stochastic Trend Processes. Working Paper, Ulm University. Sweeting, P., 2011. A Trend-Change Extension of the Cairns-Blake-Dowd Model. Annals of Actuarial Science, 5: 143 162. 17 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Contact Johannes Schupp(M.Sc.) +49 (731) 20 644-241 j.schupp@ifa-ulm.de 18 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Appendix Comparison with other AMT Models See Börger and Schupp (2015) RWD: Bivariate random walk with one constant drift Preselection of data history; here: data since last breakpoint Sweeting (2011): Identification of trend model with Chow-test Magnitude of changes normally distributed with mean 0 Chan et al. (2014): VARIMA process Extrapolation of trends and errors Hunt and Blake (2014) Random walk with variable drift With parameter uncertainty 19 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend

Appendix Comparison with other AMT Models Remaining period life expectancy for a 60-year old (5 th and 95 th percentiles) by different approaches. Comparable medians but extreme differences in the percentiles Confidence bounds for RWD, VARIMA seem too narrow; Sweeting s approach produces unrealistically large bounds Trend process produces plausible confidence bounds Possible continuation of latest improvements 20 October 2017 It Takes Two: Why Mortality Modeling is more than modeling one Mortality Trend