Managing Longevity Risk: The Case for Longevity-Indexed Variable Expiration Bonds

Abstract

There is an annuity puzzle in that the actual allocation by individuals to annuities is low. Longevity bonds, to hedge overall economy-wide mortality risk, have been proposed, but these bonds have challenges and the proponents have not shown how governments are hedged. This paper recommends that governments should create Longevity-Indexed Variable Expiration (LIVE) bonds instead. These cohort-specific bonds, targeted to individuals (and institutions) would pay income only, and they would start paying only after the average life expectancy of that cohort. Payments will be based on tax collections of that cohort, ensuring the government is fully hedged, and therefore a natural, low credit risk, issuer. Another innovation covers the life expectancy of those whose lives are shorter than the average, so only those individuals who live beyond the average (usually wealthier portions of the population) and with high risk of outliving their resources need to purchase LIVE bonds. LIVE bonds benefit individuals who want a low-cost and liquid longevity hedge with the ability to bequeath balances on death. This paper also briefly discusses the portfolio strategies of those living beyond average life expectancy and how governments can ensure that they have sufficient funds to bear this risk.

Keywords: Annuity Puzzle, Longevity Risk, Longevity Bonds, BFFS, Selfies, Live Bonds, Financial Innovation

JEL Classification: G10, G11