The Impact of Aggregate Mortality Risk on Defined Benefit Pension Plans

Boston College Center for Retirement Research Working Paper No. 2006-21

36 Pages Posted: 28 Aug 2013

See all articles by Irena Dushi

Irena Dushi

U.S. Social Security Administration

Leora Friedberg

University of Virginia - Department of Economics; National Bureau of Economic Research (NBER)

Anthony Webb

Boston College - Center for Retirement Research

Date Written: November 1, 2006

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.

Suggested Citation

Dushi, Irena and Friedberg, Leora and Webb, Anthony, The Impact of Aggregate Mortality Risk on Defined Benefit Pension Plans (November 1, 2006). Boston College Center for Retirement Research Working Paper No. 2006-21. Available at SSRN: https://ssrn.com/abstract=2316941 or http://dx.doi.org/10.2139/ssrn.2316941

Irena Dushi (Contact Author)

U.S. Social Security Administration ( email )

Washington, DC 20254
United States

Leora Friedberg

University of Virginia - Department of Economics ( email )

P.O. Box 400182
Charlottesville, VA 22904-4182
United States
804-924-3225 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Anthony Webb

Boston College - Center for Retirement Research ( email )

Fulton Hall 550
Chestnut Hill, MA 02467
United States

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