Cash Flow Swap Mechanism for Longevity Risk Transfer
Find Innovative SolutionsGenerate Solutions
Solution Overview
Problem
Existing methods for managing longevity risk in life settlements, such as mortality wraps and annuities, are expensive, inflexible, and do not adequately account for complex mortality distributions, leading to unpredictable cash flows and potential losses for investors.
Innovation Solution
A cash flow swap mechanism that transfers the difference between forecasted and actual cash flows associated with mortality-affected assets or liabilities over predetermined periods, allowing for frequent mark-to-market valuation and reducing credit risk asymmetry, while considering multiple moments of the mortality distribution.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Reliability
If mortality wraps or annuities are used to manage longevity risk, then longevity risk protection is provided, but the cost is high and flexibility is reduced
Solution Approach 1:
The patent introduces a swap mechanism as an intermediary financial instrument between the life settlement investor and a counterparty. This swap allows the investor to transfer longevity risk without being locked into traditional mortality wraps or annuities, providing greater flexibility in managing the risk while maintaining reliable protection through the swap agreement's predetermined cash flow structure
Solution Approach 2:
The patent enables dynamic cash flow adjustments through the swap mechanism, allowing the investor to receive predetermined cash flows that can be adjusted based on actual mortality experience. This dynamic structure provides flexibility unlike static traditional products, while maintaining reliability through the contractual obligations of the swap agreement
2Device complexity
If traditional mortality models are used, then simplicity is maintained, but complex mortality distributions cannot be adequately accounted for
Solution Approach 1:
The patent changes the parameters used in mortality modeling by incorporating multiple moments of the mortality distribution (mean, variance, skewness, kurtosis) rather than relying on simple average life expectancy. This allows the model to accurately capture complex mortality patterns while maintaining a structured approach that builds upon traditional modeling frameworks
Solution Approach 2:
The patent combines multiple modeling elements into a composite cash flow model that integrates traditional mortality assumptions with higher-order distribution moments. This composite approach maintains the simplicity of traditional models where applicable while adding the precision needed to handle complex mortality distributions through the incorporation of additional statistical parameters
3Ease of operation
If cash flow swaps are implemented, then flexibility and cost-effectiveness are improved, but credit risk asymmetry must be managed
Solution Approach 1:
The patent applies preliminary anti-action by establishing predetermined cash flow terms in the swap agreement before the longevity risk materializes. The counterparty commits to making predetermined cash flow payments regardless of actual mortality experience, which pre-empts credit risk issues by locking in the payment obligation in advance. This allows the investor to achieve flexibility in risk management while the counterparty assumes the credit risk in a controlled manner
Data Source
AI summary
A method for transferring longevity comprising: receiving an order to trade a financial instrument associated with at least one asset or liability affected by longevity risk; calculating a morbidity description for at least one age of each individual, a survivorship distribution and a mortality distribution, a net cash flow projection distribution, where each distribution value in the net cash flow projection distribution is computed as the probability-adjusted cash in-flow expected over a period, less the probability-adjusted cash out-flow expected over the same period; calculating a net present and net forward value distribution; accepting starting and ending dates over which counterparties wish to exchange the difference to provide at least one exposure period; accepting an input for computing a performance bond; receiving through a computing device, over time, updated mortality information and morbidity information; and recalculating distributions affected to provide recalculated distributions; calculating the difference to be exchanged.