Forward thinking

A forward contract is an agreement between two parties to buy or sell an asset at a specified price at a date in the future. It is typically a private arrangement used by one or both parties to manage their risk, or where one party wishes to speculate.

A new innovation is the idea of a survivor forward, or S-forward, which is based on the concept of the survival curve. The two parties will agree on what the neutral or best-estimate survival probability will be to a certain age, and the actual survival probability will determine who pays whom and how much. If the two parties do not agree on a neutral survival probability, one may pay the other a premium. Since the future survival curve involves considerable uncertainty, contracting parties will want to use stochastic projection models to assess potential payoffs or losses and how likely they might be.

The advent of the survivor forward will enable pension schemes and annuity portfolios to partially hedge their exposure to mortality improvements. It will also enable investors in longevity risk to gain exposure without having to worry about the peculiarities of a specific portfolio, such as concentration risk. A particular advantage for all concerned may be the ability to draw additional capital into the market. Hitherto investors had to buy exposure to longevity risk via an insurer or reinsurer, along with the attendant risk in interest rates, credit risk and regulatory risk.  These extra risks would have put off some investors, but now they can get purer exposure to longevity risk on its own via survivor forwards.  This will expand capital capacity for managing longevity risk in pension schemes and annuity portfolios.