Systematic Longevity Risk: To Bear or to Insure?

Abstract

We compare two contracts for managing systematic longevity risk in retirement: a collective arrangement that distributes the risk among participants, and a market-provided annuity contract. We evaluate the contracts’ appeal with respect to the retiree’s welfare, and the viability of the market solution through the financial reward to the annuity provider’s equityholders. We find that individuals find it more attractive to bear longevity risk under a collective arrangement than to insure it with a life insurers’annuity contract subject to insolvency risk (albeit small). Under realistic capital provision hypotheses, the annuity provider is incapable of adequately compensating its equity holders for bearing systematic longevity risk.

Keywords: longevity risk, group self-annuitization (GSA), insurance, variable annuity

JEL Classification: D14, E21, G22, G23