Stochastic modeling of assets and liabilities with mortality risk

TL;DR

This paper presents a comprehensive stochastic model for assets and liabilities in pension insurance, capturing multiple risk factors and dependencies, enabling efficient scenario analysis and calibration to data and forecasts.

Contribution

It introduces an interpretable, multivariate stochastic framework for modeling asset returns and mortality-linked liabilities, with efficient scenario generation capabilities.

Findings

Model can generate a million scenarios in minutes.

Framework effectively captures dependencies among risk factors.

Application demonstrates practical asset-liability analysis.

Abstract

This paper describes a general approach for stochastic modeling of assets returns and liability cash-flows of a typical pensions insurer. On the asset side, we model the investment returns on equities and various classes of fixed-income instruments including short- and long-maturity fixed-rate bonds as well as index-linked and corporate bonds. On the liability side, the risks are driven by future mortality developments as well as price and wage inflation. All the risk factors are modeled as a multivariate stochastic process that captures the dynamics and the dependencies across different risk factors. The model is easy to interpret and to calibrate to both historical data and to forecasts or expert views concerning the future. The simple structure of the model allows for efficient computations. The construction of a million scenarios takes only a few minutes on a personal computer. The approach is illustrated with an asset-liability analysis of a defined benefit pension fund.