Avoiding a longevity catastrophe: Harnessing longevity indices to mitigate individual, institutional and systemic longevity risks

Abstract

This paper considers the financial implications of an extreme increase in life expectancy for: (i) individuals with defined contribution pension plans and other forms of retirement savings; (ii) institutions such as defined benefit pension plans, insurance companies and reinsurers; and (iii) the financial system and economy as a whole. An extreme longevity scenario, as the IMF first acknowledged in 2006, is a long-term systemic risk that could impair the operation of the financial system with severe ramifications for the global economy. It also poses a significant risk to individuals who might live beyond the time that their retirement savings can support them. This paper explores one under-utilised way to mitigate these risks, viz., longevity index hedges, which can transfer longevity risk simply, rapidly and transparently away from where it is concentrated to a much broader set of organisations with appropriate levels of risk capital. For the market in these index hedges to grow requires a shared understanding of the hedges and their risk reduction potential by the insurance industry and regulators.