The Impact of Aggregate Mortality Risk on Defined Benefit Pension Plans
AbstractWe calculate the risk faced by defined benefit plan providers arising from uncertain aggregate mortality — the risk that the average participant will live longer than expected. First, comparing the widely cited Lee-Carter model to industry benchmarks, we show that plan providers appear to substantially underestimate the longevity of their employees. The resultant understatement of liabilities is 15.2 percent, when weighted by the characteristics of typical male participants in defined benefit plans, and reaches as much as 25.2 percent for male workers aged 22. Next, we consider the substantial mortality risk that arises even if plan providers were to use the Lee-Carter model or other unbiased forecasts of mortality reductions. We calculate the consequences for plan liabilities if aggregate mortality declines unexpectedly faster than is predicted by an unbiased projection. There is a 5 percent chance that liabilities of a terminated plan would be 2.9 to 5.1percent higher than what is expected, depending on the mix of workers covered. Lastly, we explain how longevity bonds might be used to transfer mortality risk from defined benefit plans to the capital markets, and we calculate a risk premium for a hypothetical frozen plan.
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Bibliographic InfoPaper provided by Center for Retirement Research in its series Working Papers, Center for Retirement Research at Boston College with number wp2006-21.
Length: 32 pages
Date of creation: Nov 2006
Date of revision: Nov 2006
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aggregate mortality risk; defined benefit; pension plans;
Other versions of this item:
- Dushi, Irena & Friedberg, Leora & Webb, Tony, 2010. "The impact of aggregate mortality risk on defined benefit pension plans," Journal of Pension Economics and Finance, Cambridge University Press, Cambridge University Press, vol. 9(04), pages 481-503, October.
- NEP-ALL-2007-08-08 (All new papers)
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