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The Journal of Alternative Investments

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Using RBOs and Megafunds to Hedge Longevity Risk and Specialty Drug Costs

Roger M. Stein
The Journal of Alternative Investments Due Diligence 2022, 24 (3) 99-123; DOI: https://doi.org/10.3905/jai.2021.1.151
Roger M. Stein
teaches finance and machine learning at New York University Stern School of Business in New York, NY
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Abstract

Longevity risk, the risk that a member of a pension plan or an annuity holder lives much longer than anticipated, can cause shortfalls in funding for writers of insurance policies, annuities, and pension benefits. Reimbursement risk, the risk faced by health benefit providers in paying for expensive new drugs, can similarly cause shortfalls for health insurance firms and other benefit providers, particularly as the costs of specialty drugs increase. These risks can be acute when scientific breakthroughs increase new drug development rates. An emerging asset class, research-backed obligations (RBOs) (Fernandez et al. 2012; Hull et al. 2019), has the potential to provide a natural hedge for a broad class of such risks. This article demonstrates how to calculate simplified, first-order portfolio-specific hedge ratios. The author presents simulation results that demonstrate the benefits of such hedges for a hypothetical health insurance portfolio facing rapid increases in reimbursement risk due to the high cost of new specialty drugs.

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The Journal of Alternative Investments: 24 (3)
The Journal of Alternative Investments
Vol. 24, Issue 3
Due Diligence 2022
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Using RBOs and Megafunds to Hedge Longevity Risk and Specialty Drug Costs
Roger M. Stein
The Journal of Alternative Investments Dec 2021, 24 (3) 99-123; DOI: 10.3905/jai.2021.1.151

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Using RBOs and Megafunds to Hedge Longevity Risk and Specialty Drug Costs
Roger M. Stein
The Journal of Alternative Investments Dec 2021, 24 (3) 99-123; DOI: 10.3905/jai.2021.1.151
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  • Article
    • Abstract
    • Pension Payers Face Increasing Longevity Risk
    • Example 1. The Cost of a Life-Extending Drug for a Pension Fund
    • Health Benefits Providers Face Increasing Reimbursement Risk
    • Example 2. The Cost of a Life-Extending Drug for a Pension Fund
    • Research-Backed Obligations (RBOs) as Hedges
    • ANNUITIES, LONGEVITY RISK, AND RESEARCH-BACKED OBLIGATIONS
    • HEDGING SOME FORMS OF LONGEVITY RISK
    • EXTENDING THE FRAMEWORK TO “HEDGE” REIMBURSEMENT RISK FOR HEALTH INSURERS
    • SIMULATIONS
    • CONCLUSION
    • ACKNOWLEDGMENTS
    • ENDNOTES
    • REFERENCES
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