Hi For part 3 'suggesting ways to better manage the negative items': For the Investment Return impact under Immediate Annuities, is the following valid? By investing in a longevity swap, the assets and liabilities are better matched and therefore there would be less of an impact from a change in yields? Thanks Em
No, I'm afraid this isn't correct for this part of the solution. A longevity swap looks at mortality risk rather than interest rate risk. So, yes a swap could be used to better match the liabilities by nature (ie they are related to mortality) by swapping fixed cashflows based on expected mortality for cashflows which vary with the actual mortality experienced. So longevity swaps could help the mortality experience (although we actually made a profit here in this case) but would have little impact on a change in yields. Note that in order for the insurer to pay the fixed leg of the longevity swap above, it needs to hold bonds of term that matche the expected annuity payments. The problem in this question is that the insurer has invested too short. So we to deal with the investment risk in the question we need to hold more longer bonds (whether we hold a longevity swap or not). Best wishes Mark
