If one is 5 years away from retirement, and would like to heldge against the possibility of annuity costs rising (because bond yields drop) at retirement then he/she should in invest in bonds. However, he can't invest in 5-year (or shorter) bonds as he will just get ytm of that bond when he bought it. What bond-durations should he be looking to invest in? Would immunisation need to be used to determine which bond-durations to invest in?
I haven't encountered this in practice, but my opinion is that you would want to invest in long term bonds (say 15 to 20 years or more if available). My reasoning is that in 5 years time you want to have similar bonds to what insurers would use to back/price annuities at that time, to mitigate the risk associated with changes in bond yields/annuity rates. Of course, that's just a rough guess and you could go into more detail using immunisation or even a full Asset Liability matching exercise if you think this is necessary. However, keep in mind of the other shortcomings of this approach, eg timing differences between fall in yields and changes to annuity prices, marketability and relative attractiveness of the individual securities which are available, reinvestment risk, etc. This may suggest that too much detail may be spurious.
