Hi, I would like to ask that: What are the differences between a value hedge & a cashflow hedge, in terms of, for example longevity swaps, s- & q-forwards? Does hedging (expected future) longevity liability value & hedging (expected future) longevity cashflow stream imply each other? What types of liabilities (e.g. under bulk annuities, future payments arise from deferred members or benefits in payment to retirees in a DB scheme) are suitable for value hedge? Similarly, what types of liabilities are suitable for cashflow hedge? Thank you.
By "value hedge" presumably you mean a hedge which will minimise differences between the value of backing assets and the value of liabilities under varying conditions? A cashflow hedge is an attempt to choose assets that generate cashflows which (closely) match the expected cashflows arising under the hedged liabilities. Immediate annuities is the classic example of a product for which close cashflow matching is commonly targeted, since such policies are not surrenderable. However, even if a product is very closely cashflow matched, this does not necessarily mean that it is "value hedged". If "liabilities" are defined simply as the BEL, then it is important to note that EIOPA's UK discount rate is calibrated to swaps. If the backing assets used for cashflow matching are government bonds, for example, then the value of these bonds will not necessarily move exactly in line with the value of equivalent swaps - so the "value hedge" breaks down to the extent of such difference (although this may be small). Similarly if other assets are used for cashflow matching, without a swap overlay. For the purposes of SA2, you would not be expected to know about technical hedging approaches which go beyond what is covered in the Core Reading (or the basic techniques covered in earlier subjects), but examiners could reasonably expect you to appreciate that interest rate hedging of the BEL would need to be based on swaps. Note also that longevity swaps (which you refer to) only hedge longevity risk - they do not hedge against investment or interest rate risk.
Hi, Mock A solution to Q1 iii on Reduction of Longevity exposure for annuities states that revision of basis from without profit to with profit is one of the possibilities. I just don't see how the np/wp basis would impact longevity exposure....
For with-profits business, risk is shared between policyholders and shareholders. For example, if this was done on a 90:10 basis then the with-profits policyholders would take on 90% of the longevity risk and the company only 10% - hence it has reduced the longevity risk exposure of the company.
