Hedging Longevity Risk in Defined Contribution Pension Schemes

Pension schemes all over the world are under increasing pressure to efficiently hedge longevity risk imposed by aging populations. In this work, we study an optimal investment problem for a defined contribution pension scheme that decides to hedge longevity risk using a mortality-linked security, typically a longevity bond. The pension scheme promises a minimum guarantee as such that members are able to purchase lifetime annuities upon retirement. The scheme manager invests into the risky and riskless assets that are available on the market, including the longevity bond. We transform the corresponding constrained optimal investment problem into a single investment portfolio optimization problem by replicating future contributions from members and the minimum guarantee provided by the scheme. We solve the resulting optimization problem using the dynamic programming principle. Through a series of numerical studies, we show that longevity risk has an important impact on investment strategy performance. Our results add to the growing evidence supporting the use of mortality-linked securities for efficient hedging of longevity risk