Abstract
The topic of basis risk in synthetic longevity transactions (where the hedge is based on a population different from the actual policy portfolio) has been a hotly debated topic. To date, no single standard has been adopted, and both regulators and market participants are increasingly pointing to this as a shortcoming in the development of the longevity risk transfer market. The authors propose a non-model specific method to decompose and quantify basis risk that is firmly grounded in economic principles. It is aligned with Solvency II and could easily be adopted by regulators as a metric for capital determination in index-based transactions. While the method is non-model specific, the authors share an example of an implementation in a stochastic mortality rate environment, in the hopes that this will help to set the stage for how basis risk is quantified in the future.
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