Forecasting age- and sex-specific survival functions : application to annuity pricing

We introduce the function principal component regression (FPCR) forecasting method to model and forecast age-specific survival functions observed over time. The age distribution of survival functions is an example of constrained data whose values lie within a unit interval. Because of the constraint, such data do not reside in a linear vector space. A natural way to deal with such a constraint is through an invertible logit transformation that maps constrained onto unconstrained data in a linear space. With a time series of unconstrained data, we apply a functional time-series forecasting method to produce point and interval forecasts. The forecasts are then converted back to the original scale via the inverse logit transformation. Using the age- and sex-specific survival functions for Australia, we investigate the point and interval forecast accuracies for various horizons. We conclude that the functional principal component regression (FPCR) provides better forecast accuracy than the Lee-Carter (LC) method. Therefore, we apply FPCR to calculate annuity pricing and compare it with the market annuity price.