Linking Annuity Benefits to the Longevity Experience: A General Framework

Abstract

The uncertainty regarding financial returns and the life expectancy, joint to the reduced social security benefits, increasingly expose individuals to the risk of outliving their post-retirement assets. However, the demand for longevity guarantees remains low, due to high costs. The providers, on their side, may be reluctant to offer non-adjustable longevity guarantees, as the risk is long-term and difficult to predict. It is therefore convenient, from both the point of view of the individual and the provider, to reconsider the design of longevity guarantees. In particular, a participating structure, providing a link to some longevity experience, could allow a sharing of losses, and possibly profits, resulting in a reduction of the cost of the retained guarantee. The literature review suggests a number of alternatives to define a longevity linking arrangement, but the topic is not yet completely explored. It is useful, in particular, to have a common framework, under which the various solutions can be interpreted and compared, also with a view to the trade-off between the retained risk and the cost of the guarantee. Developing a general framework describing longevity-linked post-retirement benefits is the main purpose of this paper. Allowing for aggregate longevity risk, we then examine suitable solutions for insurance products.

Keywords: Longevity-Linked Annuities, Longevity Risk Participating Annuities, Aggregate Longevity Risk, Longevity Guarantee

JEL Classification: G22