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The impact of aggregate mortality risk on defined benefit pension plans


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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Article provided by Cambridge University Press in its journal Journal of Pension Economics and Finance.

Volume (Year): 9 (2010)
Issue (Month): 04 (October)
Pages: 481-503

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Handle: RePEc:cup:jpenef:v:9:y:2010:i:04:p:481-503_99
Contact details of provider: Postal: Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK
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  1. Angus S. Deaton & Christina Paxson, 2004. "Mortality, Income, and Income Inequality over Time in Britain and the United States," NBER Chapters, in: Perspectives on the Economics of Aging, pages 247-286 National Bureau of Economic Research, Inc.
  2. 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, vol. 73(4), pages 687-718.
  3. 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.
  4. Dushi, Irena & Webb, Anthony, 2004. "Household annuitization decisions: simulations and empirical analyses," Journal of Pension Economics and Finance, Cambridge University Press, vol. 3(02), pages 109-143, July.
  5. Shenyi Jiang & Wei Sun & Anthony Webb, 2011. "Did the Housing Boom Increase Household Spending?," Issues in Brief ib2011-10, Center for Retirement Research, revised Aug 2011.
  6. Shripad Tuljapurkar & Carl Boe, . "Mortality Change and Forecasting: How Much and How Little Do We Know?," Pension Research Council Working Papers 98-2, Wharton School Pension Research Council, University of Pennsylvania.
  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. Ronald Lee & Timothy Miller, 2001. "Evaluating the performance of the lee-carter method for forecasting mortality," Demography, Springer, vol. 38(4), pages 537-549, November.
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