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The Impact of Aggregate Mortality Risk on Defined Benefit Pension Plans

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Author Info

  • Irena Dushi
  • Leora Friedberg

    ()
    (Department of Economics, University of Virginia)

  • Anthony Webb

    (Center for Retirement Research)

Abstract

We 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 Info

Paper provided by Center for Retirement Research in its series Working Papers, Center for Retirement Research at Boston College with number wp2006-21.

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Length: 32 pages
Date of creation: Nov 2006
Date of revision: Nov 2006
Handle: RePEc:crr:crrwps:wp2006-21

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Keywords: aggregate mortality risk; defined benefit; pension plans;

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  1. Dushi, Irena & Webb, Anthony, 2004. "Household annuitization decisions: simulations and empirical analyses," Journal of Pension Economics and Finance, Cambridge University Press, Cambridge University Press, vol. 3(02), pages 109-143, July.
  2. Angus Deaton & Christina Paxson, 2001. "Mortality, Income, and Income Inequality Over Time in Britain and the United States," NBER Working Papers 8534, National Bureau of Economic Research, Inc.
  3. Anthony Webb & Shenyi Jiang & Wei Sun, 2010. "Did the Housing Boom Increase Household Spending," Issues in Brief, Center for Retirement Research ib2010-10, Center for Retirement Research, revised Jul 2010.
  4. Jeffrey R. Brown & Peter R. Orszag, 2006. "The Political Economy of Government-Issued Longevity Bonds," Journal of Risk & Insurance, The American Risk and Insurance Association, The American Risk and Insurance Association, vol. 73(4), pages 611-631.
  5. Andrew J. G. Cairns & David Blake & Kevin Dowd, 2006. "A Two-Factor Model for Stochastic Mortality with Parameter Uncertainty: Theory and Calibration," Journal of Risk & Insurance, The American Risk and Insurance Association, The American Risk and Insurance Association, vol. 73(4), pages 687-718.
  6. Ronald Lee & Timothy Miller, 2001. "Evaluating the performance of the lee-carter method for forecasting mortality," Demography, Springer, Springer, vol. 38(4), pages 537-549, November.
  7. Alan L. Gustman & Thomas L. Steinmeier & Olivia Mitchell, 1994. "The role of pensions in the labor market: A survey of the literature," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 47(3), pages 417-438, April.
  8. Shripad Tuljapurkar & Carl Boe, . "Mortality Change and Forecasting: How Much and How Little Do We Know?," Pension Research Council Working Papers, Wharton School Pension Research Council, University of Pennsylvania 98-2, Wharton School Pension Research Council, University of Pennsylvania.
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Cited by:
  1. Joelle H. Fong & John Piggott & Michael Sherris, 2012. "Public Sector Pension Funds in Australia: Longevity Selection and Liabilities," Working Papers, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales 201217, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.
  2. Shin, Inyong, 2012. "The Effect of Pension on the Optimized Life Expectancy and Lifetime Utility Level," MPRA Paper 41374, University Library of Munich, Germany.
  3. John Kiff & Michael Kisser & Mauricio Soto & Stefan E. Oppers, 2012. "The Impact of Longevity Improvements on U.S. Corporate Defined Benefit Pension Plans," IMF Working Papers, International Monetary Fund 12/170, International Monetary Fund.

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