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Securitizing and Tranching Longevity Exposures

Enrico Biffis and David Blake

We consider the problem of optimally designing longevity
risk transfers under asymmetric information. Holders of longevity expo-
sures have superior knowledge of the underlying demographic risks, but
are willing to take them off their balance sheets because of capital re-
quirements. In equilibrium, they transfer longevity risk to uninformed
agents at a cost, where the cost is represented by retention 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, tranching.