Thursday, July 8, 2010

What if a cohort lives too long?

Pension funds, life and health insurance companies suffer from a substantial long-term risk: What if their members live longer that expected? While they tend to work with actuarial tables to set premiums and benefits, those tables a re backward-looking, and to price things correctly, the insurers need to make accurate projections about future demographics. But if there is risk, there should be a way to insure oneself against it if a counter-party is willing to take that risk.

David Blake, Tom Boardman and Andrew Cairns make the case that insurance companies should be putting longevity bonds on the market, whose payouts are tied to the demographics of a particular cohort. Imagine an insurance company is selling annuities, but medical developments let some cohorts live unexpectedly longer. By reducing payouts on those cohorts' longevity bonds, the company can finance the shortfall. The question is then who is willing to buy those bonds. Certainly not the cohorts in question. They have annuities already, and those who do not would want a higher payout, not a lower one. Pharmaceutical companies are good candidates, as they face an inverse risk: if a cohort lives shorted than expected, the return from many drugs suffers. But is this enough?

2 comments:

armchair economist said...

Can anyone say "moral hazard"? Think of the lobbying opportunities for bond-holders - to reduce public health spending, to reduce regulation of say hazardous chemicals or dubious food "innovations".

andrewbavol said...
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