DISCUSSION PAPER PI-0601

Living with Morality: Longevity Bonds and other Mortality-Linked Securities D.Blake, A.J.G Cairns and K.Dowd ABSTRACT This paper addresses the problem of longevity risk ö the risk of uncertain aggregate mortality ö and discusses the ways in which life assurers, annuity providers and pension plans can manage their exposure to this risk. In particular, it focuses on how they can use mortality- linked securities and over-the-counter contracts ö some existing and others still hypothetical ö to manage their longevity risk exposures. It provides a detailed analysis of two such securities ö the Swiss Re mortality bond issued in December 2003 and the EIB/BNP longevity bond announced in November 2004. It then looks at the universe of hypothetical mortality-linked securities ö other forms of longevity bonds, swaps, futures and options ö and investigates their potential uses. It also addresses implementation issues, and draws lessons from the experiences of other derivative contracts. Particular attention is paid to the issues involved with the construction and use of mortality indices, the management of the associated credit risks, and possible barriers to the development of markets for these securities. It suggests that these implementation difficulties are essentially teething problems that will be resolved over time, and so leave the way open to the development of flourishing markets in a brand new class of securities.