mandated for discounting unmatched liabilities. Coupled with higher capital reserve requirements for unmatched liabilities, this approach protects providers of fixed life annuities from adverse changes in interest rates.

4.91 Full matching of assets and liabilities minimizes exposure to investment and inflation risks but, as discussed in section 3.2, may prove overly expensive and even infeasible. It requires full access to long-duration inflation-indexed financial instruments for hedging the inflation risk of fixed real annuities. However, most countries do not have an adequate supply of such instruments. Use of various derivatives, including interest rate swaps and swaption contracts as well as interest rate futures and callable debt, may be used for managing investment and prepayment risks, but it is essential to monitor closely the use of such products and the counterparty risk they entail.

4.92 The regulation of the management of longevity risk also faces major challenges. An essential requirement is to avoid the use of outdated mortality tables, which may be particularly detrimental in annuity pricing but may also cause problems for reserving policies. Developing countries tend to use outdated mortality tables because they lack comprehensive local data and rely extensively on mortality data from foreign countries. A serious effort must be made to build reliable and detailed data on longevity.

4.93 Reinsurance is an option for managing longevity risk, especially at the tail end of the age distribution. However, regulators need to remove any restrictions on the localization of insurance assets to encourage resort to global reinsurance markets. The use of reinsurance needs to be closely monitored to ensure that foreign reinsurers are respectable and creditworthy.

4.94 The use of longevity bonds and longevity derivatives could be encouraged when these instruments are well established in global markets. However, the development of deep and reliable markets in these instruments is likely to take considerable time. In the meantime, providers of products with investment and longevity risks could adopt risksharing arrangements with annuitants. Risk sharing is widely used in Denmark and Sweden for both traditional participating 'guarantee and bonus' annuities and for unitlinked annuities.

4.95 In the former case, providers assume the investment and longevity risks up to the level of guaranteed benefits but share these risks among annuitants beyond that level. In the latter case, the investment risk is assumed by annuitants reflecting the portfolio of the investment funds they select but the longevity risk is shared among annuitants either on a cohort and product basis or across all annuitants of each type of product. Improvements in longevity as well as changes in investment returns are reflected in annual benefits.

4.96 Risk-sharing arrangements have many potential advantages but also introduce their own challenges. A high level of transparency and integrity on the part of annuity providers is required as well as transparent and robust rules to ensure consistent longterm fairness in the distribution of profits between shareholders and policyholders. This is clearly a more important issue in the case of decentralized markets, where market 46