A new way to protect against individuals’ outliving their savings could be a “longevity bond,” according to a new academic paper.
Theoretically, such bonds would be issued by the government and would act as a hedge for pension plans and insurers. Longevity risk — the possibility that the average member of a group born in a certain year will live beyond his estimated lifespan — is difficult for insurers and pension funds to hedge through creating a pool of individuals, wrote David Blake, director of the Pensions Institute at the Cass Business School in London.
A longevity bond, however, could change the equation. Plus it wouldn’t involve repayment of principal, and it would pay a coupon that’s linked to the survivorship of a particular cohort.
For example, such a bond can cover the lives of men born in 1945 and who survive year after year, according to the paper. The bond won’t make coupon payments during years when the longevity risk is low, and once payments start, they may continue until the bond’s maturity date when the lives in a given group are at an advanced age.
In that manner, the bond is a perfect hedge for insurers and pension plans that have members with a mortality experience that’s similar to the group of underlying lives in the bond, said Mr. Blake, who co-wrote “The Case for Longevity Bonds,” published by the Center for Retirement Research at Boston College. Tom Boardman, a visiting professor at the Pensions Institute, and Andrew Cairns, a fellow there, were also co-authors.
Insurers may have to turn to the government to provide the bonds in the needed volume, though some say this would be a bad idea given the government’s large exposure to
Social Security and public pension funds. But as an issuer, the government would receive premiums and would be in control of raising the age of retirement if longevity peaks, the paper found.
Longevity risk, of course, isn’t exclusive to retirees, as institutions that make lifetime payments to individuals face the risk that those people will live long lives and endanger the institutions’ solvency, according to the paper.
Aggregate longevity risk is especially problematic for carriers that provide lifetime-income annuities. If mortality rates plummet, it can lead to higher costs and reduced annuity income as insurers try to shore up capital for the payouts, according to the paper.
