Securitizing and Tranching Longevity Exposures

Enrico Biffis and David Blake

We consider the problem of optimally designing longevity risk transfers
under asymmetric information. We focus on holders of longevity exposures
that have superior knowledge of the underlying demographic risks, but are
willing to take them off their balance sheets because of capital requirements.
In equilibrium, they transfer longevity risk to uninformed agents at a cost,
where the cost is represented by reten- tion of part of the exposure and/or
by a risk premium. We use a signalling model to quantify the effects of
asymmetric information and emphasize how they compound with parameter
uncertainty. We show how the cost of private information can be minimized by
suitably tranching securitized cashflows, or, equivalently, by securitizing the
exposure in exchange for an option on mortality rates. We also investigate the
benefits of pooling several longevity exposures and the impact on tranching levels.

Keywords: longevity risk, asymmetric information, security design, pooling,

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