Standardized Mortality Derivatives Hedge Portfolio Risk
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Solution Overview
Problem
Current methods for hedging mortality risk in portfolios of mortality-sensitive instruments are inefficient due to customized and illiquid derivatives, high negotiation costs, and lack of a systematic technique for determining portfolio-specific mortality risk, leading to significant financial risks for insurance companies and pension plans.
Innovation Solution
A system and method using standardized building block mortality derivatives, segmented by age, gender, and other variables, which can be traded on both primary and secondary markets to create a portfolio-specific hedge against mortality and longevity risks, allowing for efficient risk transfer and mitigation.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Adaptability or versatility
If customized mortality derivatives are used to hedge portfolio risk, then the hedge can be tailored to specific portfolio needs, but transaction costs increase and liquidity decreases
Solution Approach 1:
The patent segments mortality risk into standardized building blocks categorized by age groups, genders, and product types. These modular components can be individually traded and combined to create customized hedges, resolving the contradiction by providing both standardization (reducing costs) and customization (maintaining adaptability).
Solution Approach 2:
The patent creates universal building block derivatives that can serve multiple portfolio types and risk profiles. These standardized instruments can be reused across different hedging scenarios, reducing negotiation costs while maintaining the ability to address specific portfolio needs through combination and aggregation.
2Adaptability or versatility
If customized mortality derivatives are used to hedge portfolio risk, then the hedge can be tailored to specific portfolio needs, but market liquidity decreases
Solution Approach 1:
By segmenting mortality risk into standardized building blocks, the patent enables these components to be independently traded on secondary markets. This segmentation increases liquidity by creating tradable standardized units while still allowing customization through aggregation, resolving the contradiction between adaptability and liquidity.
3Device complexity
If traditional mortality risk assessment methods are used, then simplicity is maintained, but measurement precision of portfolio mortality risk decreases
Solution Approach 1:
The patent segments portfolio mortality risk by age groups, genders, and product types, enabling precise measurement of each segment's risk contribution. This segmented approach maintains manageable complexity while dramatically improving measurement precision through granular analysis of different risk segments.
Solution Approach 2:
The patent applies different assessment methodologies and parameters to different segments of the portfolio based on their specific characteristics (age, gender, product type). This local quality approach improves overall measurement precision by tailoring the assessment to each segment's unique risk profile rather than applying a uniform simple method.
Data Source
AI summary
The invention comprises a system and method for hedging or mitigating mortality exposure risk in a portfolio of mortality-dependent instruments. A mortality risk or longevity risk of the portfolio is calculated or otherwise determined. Then the sensitivity of the portfolio to mortality risk or longevity risk is calculated or otherwise determined, in other words, how much is cost or value of the portfolio affected by a change in mortality rate. To account for that mortality exposure, a selection is made of building block mortality derivatives that include age-based mortality derivatives. The selected plurality of building block mortality derivatives are used to create a hedge against the mortality risk or longevity risk of the portfolio.