Using Reverse Mortages to Hedge Longevity and Financial Risks for Life Insurers: A Generalized Immunization Approach

Abstract

The launch of new innovative longevity-linked products, such as reverse mortgages, increases the complexity and challenges faced by insurers in implementing an asset-liability management strategy. With the house price dynamic and a large final payment received at the end of the policy year, a reverse mortgage provides a different liability duration pattern from an annuity. In this paper, we propose a generalised immunisation approach to obtain an optimal product portfolio for hedging the longevity and financial risks of life insurance companies. The proposed approach does not rely on specific assumptions regarding mortality models or interest rate models. As long as the scenarios generated by the adopted models are highly correlated, the proposed approach should be effective. By using stochastic mortality and interest rate models and the Monte Carlo simulation approach, we show that the proposed generalised immunisation approach can serve as an effective vehicle to control the aggregate risk of life insurance companies. The numerical results further demonstrate that adding the reverse mortgage to the insurers’ product portfolio creates a better hedging effect and effectively reduces the total risk associated with the surplus of the life insurers.