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The Political Economy of Government-Issued Longevity Bonds

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  • Jeffrey R. Brown
  • Peter R. Orszag

Abstract

This article explores the trade-offs associated with government issuance of longevity bonds as a way of stimulating private annuity supply in the presence of aggregate mortality risk. We provide new calculations suggesting a 5 percent chance that aggregate mortality risk could "ex post" raise annuity costs for private insurers by as much as 5-10 percentage points, with the most likely effect based on historical patterns toward the lower end of that range. While we suspect that aggregate mortality risk does exert some upward pressure on annuity prices, evidence from private market pricing suggests that, to the extent that private insurers are accurately pricing this risk, the effect is less than 5 percentage points. We discuss ways that the private market can spread this risk, while emphasizing that the government has the unique ability to spread aggregate risk across generations. We note factors that might hamper such an efficient allocation of risk, including potential political incentives for the government to shift more than the optimal amount of risk onto future generations, and the possibility that government fiscal policy might allocate risk less efficiently within each generation than would private markets. We also discuss how large-scale longevity bond issuance might affect government borrowing costs, as well as political economy aspects of how the proceeds from such a bond issuance might be used. Copyright The Journal of Risk and Insurance, 2006.

Suggested Citation

  • 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, vol. 73(4), pages 611-631.
  • Handle: RePEc:bla:jrinsu:v:73:y:2006:i:4:p:611-631
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    References listed on IDEAS

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    1. Cassio M. Turra & Olivia S. Mitchell, 2004. "The Impact of Health Status and Out-of-Pocket Medical Expenditures on Annuity Valuation," Working Papers wp086, University of Michigan, Michigan Retirement Research Center.
    2. Jeffrey R. Brown & Amy Finkelstein, 2008. "The Interaction of Public and Private Insurance: Medicaid and the Long-Term Care Insurance Market," American Economic Review, American Economic Association, vol. 98(3), pages 1083-1102, June.
    3. Kent A. Smetters, 2003. "Trading with the Unborn: A New Perspective on Capital Income Taxation," NBER Working Papers 9412, National Bureau of Economic Research, Inc.
    4. Henning Bohn, 2003. "Will Social Security and Medicare Remain Viable as the U.S. Population is Aging? An Update," CESifo Working Paper Series 1062, CESifo Group Munich.
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    Citations

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    Cited by:

    1. Nicolas R Blancher & François Haas & John Kiff & Oksana Khadarina & Paul S. Mills & Parmeshwar Ramlogan & William Lee & Yoon Sook Kim & Todd Groome & Shinobu Nakagawa, 2006. "The Limits of Market-Based Risk Transfer and Implications for Managing Systemic Risks," IMF Working Papers 06/217, International Monetary Fund.
    2. Maathumai Nirmalendran & Michael Sherris & Katja Hanewald, 2012. "Solvency Capital, Pricing and Capitalization Strategies of Life Annuity Providers," Working Papers 201213, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.
    3. Huang, Rachel J. & Tsai, Jeffrey T. & Tzeng, Larry Y., 2008. "Government-provided annuities under insolvency risk," Insurance: Mathematics and Economics, Elsevier, vol. 43(3), pages 377-385, December.
    4. 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, vol. 9(04), pages 481-503, October.
    5. Bauer, Daniel & Börger, Matthias & Ruß, Jochen, 2010. "On the pricing of longevity-linked securities," Insurance: Mathematics and Economics, Elsevier, vol. 46(1), pages 139-149, February.
    6. Broeders, Dirk & Chen, An & Koos, Birgit, 2011. "A utility-based comparison of pension funds and life insurance companies under regulatory constraints," Insurance: Mathematics and Economics, Elsevier, vol. 49(1), pages 1-10, July.
    7. Jeffrey R. Brown, 2007. "Rational and Behavioral Perspectives on the Role of Annuities in Retirement Planning," NBER Working Papers 13537, National Bureau of Economic Research, Inc.
    8. John Chalmers & Jonathan Reuter, 2012. "How Do Retirees Value Life Annuities? Evidence from Public Employees," Review of Financial Studies, Society for Financial Studies, vol. 25(8), pages 2601-2634.
    9. Dirk Broeders, 2010. "Valuation of Contingent Pension Liabilities and Guarantees Under Sponsor Default Risk," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(4), pages 911-934.
    10. Dirk Broeders & An Chen & Birgit Koos, 2009. "An institutional evaluation of pension funds and life insurance companies," DNB Working Papers 227, Netherlands Central Bank, Research Department.
    11. Ngai, Andrew & Sherris, Michael, 2011. "Longevity risk management for life and variable annuities: The effectiveness of static hedging using longevity bonds and derivatives," Insurance: Mathematics and Economics, Elsevier, vol. 49(1), pages 100-114, July.
    12. Schuhmacher, Petra, 2008. "The Demand for Enhanced Annuities," Discussion Papers in Business Administration 7954, University of Munich, Munich School of Management.
    13. Roman N. Schulze & Thomas Post, 2010. "Individual Annuity Demand Under Aggregate Mortality Risk," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(2), pages 423-449.

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