Q-forward (mortality forward contract)
A forward contract that exchanges, at a future date, a mortality rate fixed in advance for the realized rate of a reference population, to hedge longevity or mortality risk.
The q-forward takes its name from the actuarial notation q, the mortality rate at a given age. At maturity, one party pays an amount proportional to the difference between a mortality rate agreed at signing and the rate actually observed in a reference population, published by an index. A pension fund or annuity insurer, which loses when people live longer than expected, receives a payment if realized mortality is lower than the fixed rate; a life insurer, exposed to the opposite risk, can take the other side. The instrument is standardized and simple, which makes it tradable, but it carries significant basis risk: mortality in the reference population, often national, may differ from that of the hedged portfolio, which is wealthier or more concentrated. It has not found the hoped-for liquidity, as large longevity risk transfers have preferred tailored longevity swaps.
JPMorgan launched the LifeMetrics mortality indices in 2007, and in January 2008 concluded with UK annuity insurer Lucida the first q-forward, based on the mortality of the population of England and Wales.
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