A Cautious Note on Natural Hedging of Longevity Risk

In this note, we examine the so-called “natural hedging” approach for life insurers to internally manage their longevity risk exposure by adjusting their insurance portfolio. In particular, unlike the existing literature, we also consider a non-parametric mortality forecasting model that averts the assumption that all mortality rates are driven by the same factor(s). Our primary finding is that higher order variations in mortality rates may considerably affect the performance of natural hedging. More precisely, while results based on a parametric single factor model—in line with the existing literature—imply that almost all longevity risk can be hedged, results are far less encouraging for the non-parametric mortality model. JEL classification: G22; G32; J11.