7

th
International Workshop on Pensions, Insurance and Savings
Modelling Mortality using Multiple
Stochastic Latent Factors
Jorge Miguel Bravo (2009)
1
Stochastic Latent Factors
JORGE MIGUEL BRAVO
University of vora Department of Economics and CIEF/CEFAGE-UE
jbravo@uevora.pt
Paris, May 28-29, 2009
Presentation Outline
1. Introduction and motivation
2. Modelling mortality and longevity risks
3. Affine-Jump diffusion processes for mortality
Jorge Miguel Bravo (2009)
2
3.1. Mathematical framework
3.2. Multiple stochastic latent factors
4. Revisiting the Gompertz-Makeham law
5. Final remarks
Introduction and motivation
Decline in mortality at all ages
Reforms in social security systems
Increase in contribution rates/retirement age
Reduction in pension/salary ratios
Defined Benefit Defined Contribution
Jorge Miguel Bravo (2009)
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Longevity risk cannot be diversified away
Changes in the regulatory framework (Solvency II)
Hedging strategies
Product redesign, natural hedging, stochastic solvency rules
New reinsurance treaties
Capital market solutions: longevity bonds, mortality-linked
derivatives,
Modelling mortality and longevity risks
Longevity-linked products market models for
mortality/longevity risk measurement
Traditional actuarial approach: deterministic mortality
intensity + best estimate interest rates
Discrete-time dynamic approach
Jorge Miguel Bravo (2009)
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Discrete-time dynamic approach
Extrapolative methods
Parametric vs statistical methods (e.g., Poisson-Lee-Carter)
Stochastic mortality modeling
Mortality intensity as a stochastic process
Time dependency and uncertainty in future development
Arbitrage-free framework
Affine-Jump diffusion processes
Main idea
Draw parallel between insurance contracts and credit-sensitive
securities
Analogy between default and insureds death and between
intensity of default and mortality intensity
Jorge Miguel Bravo (2009)
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Mathematical framework
Complete filtered probability space
Random lifetime of an individual aged x at time 0 as an
stopping time with random intensity
where is the first jump-time of a nonexplosive counting
process recording at any time whether the individual as
died or survived
x

N
x

0 ( )
t
N 0 ( )
t
N =
Mathematical framework
Then, for such that we can write
Assuming that N is a Cox process with predictable
intensity , then
0, , t ( ) ,
x
t >
( )
( )
t t t t x
E N N F t t
+

x

Jorge Miguel Bravo (2009)

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Model the survival probability by using affine-jump
diffusion processes
x
( )
( )
T
x s
t
s ds
x t t
P T F E e F

> =
(

1
( , ) ( , )
m
h
t t t t t
h
dX t X dt t X dW dJ
=
= + +

Multiple Latent Factors Approach
Pioneered by Schrager (2006)
Goal: model the intensity
x+t
(t) for all ages simultaneously
Assumption
with M-dimensional factor dynamics
0
1

+
=
= +

( ) ( , ) ( , ) ( )
M
x t j j
j
t g x t g x t X t
Jorge Miguel Bravo (2009)
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with M-dimensional factor dynamics
Instantaneous drift, variance-covariance matrix and jump-arrival
intensity are affine functions of the latent factors
Main contribution of paper: inclusion of positive/negative jumps
0 = + + = ( ) ( ( )) ( ), ( ) ,
P
t t
dX t X t dt V dW dJ t X X
Multiple Latent Factors Approach
Survival probability represented by an exponential affine function
Feyman-Kac representation

+ +
= + = (

exp ( ) ( ) ( ) ,
T t x t x t
p A B t T t
{ }
2
1
1
2

=

+ + + + (

( ) ( )
M
t t t t t t i i t
i
i
A B X X B B X
Jorge Miguel Bravo (2009)
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Where A
t
and B
t
are solutions of Riccati ODE
{ }
( )
1
0 1 0
1
2
1 0
=
=

(
+ + + =

( , ) ( , ) ( , )
i
m
h h h
t t t
h
X t B g x t X g x t
2
0 0
1 1
2
1
1 1
1
1
2
1
1
2


= =
= =
(
= + (


(
= + (

( , ) ( , )
( , ) ( , )
M m
h h
t t t i t
i
i h
M m
h h
t t t i t
i
i h
A B B t B g x t
B B B t B g x t
Revisiting Gompertz-Makeham law
Gompertz-Makeham (GM) deterministic mortality law
GM stochastic mortality law
1 1 1 2
0 1
+
+
= + > > , , ,
x t
x t
X X c X X c
1 1

+
+
= + ( ) ( ) ( )
x t
x t
t X t X t c
Jorge Miguel Bravo (2009)
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with factor X
j
(j=1,2) dynamics
1 1

+
= + ( ) ( ) ( )
x t
t X t X t c
1 2
0

= + + =
=
( ) ( ( )) ( ), ( ) ,
P
j
j j j j j jt j j
P P
t t
dX t a X t dt dW dJ t X X
dW dW dt
0 0 0 > > > , ,
j j j
a
Including jumps
We assume J(t) is a compound Poisson process with constant
jump-arrival intensity
Jump sizes with double asymmetric exponential distribution
1

=
=

( ) , i.i.d.
t
N
i i
i
J t
0
Jorge Miguel Bravo (2009)
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Jump sizes with double asymmetric exponential distribution
1 2
1 1
1 0 2 0
1 2
1 2 1 2 1 2
1 1
0 1

<
| | | |
= +
| |
\ \
+ =
{ } { }
( )
, , , ,
z z
f z e I e I
1 2 1 2
= ( ) Prob of positive (negative) jumps with average size ( )
Gompertz-Makeham model
Survival probability
A
t
and B
j
(j=1,2) are solutions of
2
1

+
=

= +
`
)

exp ( ) ( , ) ( )
T t x t j j
j
p A B x X t
1 1 1
1 =

( ) ( ) B a B
Jorge Miguel Bravo (2009)
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Boundary conditions:
1 1 1
2 2 2
2
2 2
2
1 2 1 2
1 1
2
1 2
1
1 2
1
2
1
1 1

+
= =
=
=
=
= + +
| |
+ +
|
|
+
\

( ) ( )
( ) ( )
( ) ( ) ( ) ( ) ( )

( ) ( )
x t
j
t j j j j
j j
j j
j
j
j j j j
B a B
B a B c
A a B B B B
B B
0 0 0 0 = = ( ) , ( )
j
B A
Closed-form solutions
By solving the system of equations, we get
1
2
1
1
2
1
1

=
| |

= =
|

\
( )
( ) ,
( ) , ln
a
a
x t
e
B
a
e
B c c
a
Jorge Miguel Bravo (2009)
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2
2
2
2 2
2
1 2 1 2
1 1
2
1 2
1
1 2
2
1
1 1

= =
=
|

\
= + +
| |
+ +
|
|
+
\

( ) ( ) ( ) ( ) ( )

( ) ( )
j
t j j j j
j j
j j
j
j
j j j j
a
A a B B B B
B B
Non-gaussian factor dynamics
Gaussian dynamics doesnt eliminate the possibility of
negative mortality rates!
Alternative specification (Feller equation with jumps)
= + + ( ) ( ( )) ( ) ( )
P
j j j j j j jt j
dX t a X t dt X t dW dJ t
Jorge Miguel Bravo (2009)
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ODE Solution numerical methods
1 2
=
P P
t t
dW dW dt
0 0 0 > > > , ,
j j j
a
Final remarks
Longevity-linked products market models for
mortality/longevity risk measurement
Issues for future research
Model calibration
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Model consistency with biological evidence
Inclusion of heterogeneity risk classification
Causes of death
Actuarial neutrality of social security systems
Market price of longevity risk
THANK YOU
Jorge Miguel Bravo (2009)
15
JORGE MIGUEL BRAVO
University of vora Department of Economics and CIEF/CEFAGE-UE
jbravo@uevora.pt