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The Impact of Aggregate Mortality Risk on Defined Benefit Pension Plans

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Author Info
Irena Dushi
Leora Friedberg () (Department of Economics, University of Virginia)
Anthony Webb (Center for Retirement Research)
Abstract

We calculate the risk faced by defined benefit plan providers arising from uncertain aggregate mortality — the risk that the average participant will live longer than expected. First, comparing the widely cited Lee-Carter model to industry benchmarks, we show that plan providers appear to substantially underestimate the longevity of their employees. The resultant understatement of liabilities is 15.2 percent, when weighted by the characteristics of typical male participants in defined benefit plans, and reaches as much as 25.2 percent for male workers aged 22. Next, we consider the substantial mortality risk that arises even if plan providers were to use the Lee-Carter model or other unbiased forecasts of mortality reductions. We calculate the consequences for plan liabilities if aggregate mortality declines unexpectedly faster than is predicted by an unbiased projection. There is a 5 percent chance that liabilities of a terminated plan would be 2.9 to 5.1percent higher than what is expected, depending on the mix of workers covered. Lastly, we explain how longevity bonds might be used to transfer mortality risk from defined benefit plans to the capital markets, and we calculate a risk premium for a hypothetical frozen plan.

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Paper provided by Center for Retirement Research in its series Working Papers, Center for Retirement Research at Boston College with number wp2006-21.

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Length: 32 pages
Date of creation: Nov 2006
Date of revision: Nov 2006
Handle: RePEc:crr:crrwps:wp2006-21

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Keywords: aggregate mortality risk defined benefit pension plans

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Dushi, Irena & Webb, Anthony, 2004. "Household annuitization decisions: simulations and empirical analyses," Journal of Pension Economics and Finance, Cambridge University Press, vol. 3(02), pages 109-143, October. [Downloadable!]
  2. Shripad Tuljapurkar & Carl Boe, . "Mortality Change and Forecasting: How Much and How Little Do We Know?," Pension Research Council Working Papers 98-2, Wharton School Pension Research Council, University of Pennsylvania. [Downloadable!]
  3. Alan L. Gustman & Thomas L. Steinmeier & Olivia Mitchell, 1994. "The role of pensions in the labor market: A survey of the literature," Industrial and Labor Relations Review, ILR Review, ILR School, Cornell University, vol. 47(3), pages 417-438, April.
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  1. Leora Friedberg & Anthony Webb, 2007. "Life Is Cheap: Using Mortality Bonds to Hedge Aggregate Mortality Risk," Topics in Economic Analysis & Policy, Berkeley Electronic Press, vol. 7(1), pages 1785-1785. [Downloadable!] (restricted)
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