Indifference pricing of mortality-linked securities

Catastrophic mortality events, such as pandemics, wreak havoc on the economy and society on a large scale despite their low likelihood of happening. For instance, the 1918 influenza pandemic took around 50 million lives. More recently, during the 2009 H1N1 influenza pandemic between 151,700 and 575,400 people perished worldwide. Even more, the Covid-19 pandemic is ongoing. Concerned with such fatalities, life insurers/reinsurers are continually seeking solutions to mitigate catastrophic risk.

The uncertainty in future death rates can be divided into two components: the unsystematic mortality risk, which can be hedged by pooling, and the systematic mortality risk due to the uncertain development of future mortality rates (for instance due to a pandemic), which is inherently undiversifiable. As an alternative to traditional reinsurance, the interplay between the insurance industry and the capital market provides a vehicle for mitigating systematic mortality risk, namely, through the financial securitization. Securitization allows off-loading undiversifiable risk from the insurer and transferring it to the capital market. In particular, the mortality-linked securities (MLS) have emerged as a way to manage systematic mortality risk. Generally speaking, MLS are financial products whose payoffs depend on mortality risk). For example, mortality catastrophe bonds have been employed by some insurance and reinsurance companies to transfer extreme mortality risks to the capital market (see, e.g., Bauer and Kramer (2016)).