Parametric Risk Transfer

There are many common examples of parametric risk transfers. For example, home insurance where the full value of the contents is not insured or critical illness cover where a fixed sum is payed out in the event of contracting a disease (rather than the medical and other costs incurred as a result of the disease).

In respect of longevity risk for a pension plan, the risk being transferred is the risk that a payee lives longer than expected, the loss is the extra benefits the pension plan must pay in addition to those expected. Examples of a parametric risk transfer would be any partial insurance of this risk, such as:

• an annuity contract that only partially covers the individuals benefit payments - this is common if the pension plan has a complicated benefit structure such as different tranches of benefits increasing at different rates
• a longevity swap where the floating leg is determined by reference to the experience of a population other than the exact lives that have been insured. Such a swap is sometimes known as an indexed-based longevity swap with the population being tracked by the floating leg known as the longevity index.

Some advantages of parametric risk transfers include the ability to structure the contract to enable predictable and rapid payouts and reduced costs arising from a simplified contract structure. For example, payouts of an index-linked longevity swap could be linked to the performance of a published longevity index, so it would be easy to keep track of the survivorship of the population determining the floating leg allowing quick payouts in certain survivorship events. In comparison, payouts from an indemnity longevity swap would require the confirmation of survivorship from a bespoke group of lives, which may be harder to track.