Longevity-Linked Annuities: How to Preserve Value Creation Against Longevity Risk

Abstract

The cost of longevity guarantees of traditional annuity products has increased in the recent scenario, characterized by declining mortality rates, in particular at unanticipated levels. Increasing the annuity loading rewarding the accepted longevity risk is not an option for annuity providers, given that individuals already consider annuities to be expensive. An alternative solution could be represented by participating structures, providing a link to some longevity experience. In particular, the benefit amount should be allowed to decrease, possibly maintaining a guaranteed minimum amount, in case of unanticipated longevity. This should be balanced by a reduction of the annuity loading or a participation to possible longevity profit.

Linking the annuity benefit amount to the longevity experience determines two opposing effects on the business value: possible losses are reduced, but also possible profits. The trade-off is not obvious and requires appropriate assessment metrics. In this paper, we measure the business value of alternative linking designs. While we follow a traditional economic logic for defining the business value, namely the present value of future profits net of the cost of capital, we suggest how to identify the main components of the present value of future profits; further, we assess the capital size according to the riskiness retained by the provider, so to make sure that the business value can represent appropriately the risk-return trade-off for the provider. The time-profile of the business value is also considered.

Keywords: Longevity risk participating annuities, Aggregate longevity risk, Longevity guarantee, Business value, Present value of future profits, Cost of capital, Market consistent embedded value

JEL Classification: G22