Longevity Risk and Pension De-Risking
How longevity risk threatens pension plans and the strategies used to transfer or mitigate that risk.
Understanding Longevity Risk
Longevity risk is the possibility that people live longer than expected, increasing the cost of pensions and annuities. For defined benefit pension plans, each additional year of life expectancy can increase liabilities by 3% to 5%. This risk is systematic, meaning it affects all participants simultaneously and cannot be diversified away within a single plan.
De-Risking Strategies
Pension sponsors use several strategies to manage longevity risk. Pension risk transfers (PRTs) shift obligations to insurance companies through group annuity contracts. Lump sum buyouts offer participants a one-time payment to exit the plan. Longevity swaps and longevity bonds transfer the risk to capital markets. Liability-driven investment (LDI) strategies match asset durations to liability durations. Each approach involves trade-offs between cost, complexity, and the degree of risk reduction achieved.