Buy-ins, buy-outs, longevity bonds, and the creation of value

Abstract Longevity risk is the risk that people on average will live longer than expected. That potential increase in life expectancy exposes corporations and pension funds to the risk of having insufficient funds to pay a more extended stream of annuity benefits. Buy-ins, buy-outs, and longevity bonds provide pension funds with insurance and financial market instruments to hedge their longevity risk. The most straightforward instruments and the most robust markets are currently for buy-ins and buy-outs. The model developed here shows that these instruments transfer value to pension holders and, other things being equal, would not be used by firms since shareholder value is reduced. The analysis, however, also shows that these instruments can be used to solve the under-investment problem created by underfunded pension plans and so increase not only the pension fund value but also the corporate stock value.