The need to manage longevity risk has come to the forefront as employers and individuals increasingly become aware of their exposure to longevity risk and their need to mitigate it. Longevity risk refers to the risk that actual survival rates and life expectancy will exceed expectations or pricing assumptions, resulting in greater-than-anticipated retirement cash flow needs. For individuals, longevity risk is the risk of outliving ones’ assets, resulting in a lower standard of living, reduced care, or a return to employment. For those institutions providing covered individuals with guaranteed retirement income, longevity risk is the risk of underestimating survival rates, resulting in increased liabilities to sufficiently cover promised payments. Institutions facing longevity risk include defined benefit pension plan providers, (re)insurance companies, and certain financial institutions.
Key drivers of the growing need to address longevity risk include an aging population, increasing life expectancy, a shift in who bears the responsibility of sufficient retirement income, uncertainty of government benefits and economic volatility. It is estimated those reaching retirement age will more than double from 2010 to 2050, jumping from an estimated 40.2 million to 88 million people.
At the same time that a growing proportion of the population is reaching retirement age, it is also living longer. According to the Census Bureau, the U.S. average life expectancy at birth increased 62% from 47.3 years in 1902 to 76.8 in 2000, with expectations it will reach 79.5 in 2020. For defined benefit plans, who are already facing pension funding deficits, the recognition of this increasing longevity places greater strain on liability funding needs. For individuals, the increase in longevity combined with the uncertainty of government benefits and departure of defined benefit plans leaves them more accountable for ensuring their own retirement income.
Longevity Risk Transfer
For many institutions, the need for relief from liabilities exposed to longevity risk has created an emerging market with innovative market-based risk transfer solutions. There are three broad longevity risk transfer mechanisms: a buy-out, a buy-in, and a longevity swap. Additionally, securities (such as longevity bonds) and indexes may emerge to facilitate longevity risk hedging. A more complete description of these risk transfer mechanisms can be found in the CIPR Newsletter article “Managing Longevity Risk.”
For individuals, insurers provide the majority of products designed to help individuals manage the risk they will outlive their assets. Individuals without defined benefit plans can ensure lifetime income by purchasing annuities within their defined contribution plans and personal retirement accounts. They can also purchase a single premium immediate annuity by taking a full or partial distribution from their defined contribution plan upon retirement or through other lump sum savings.
Insurers have introduced many new product designs to accommodate the growing demand for lifetime income. Over the past decade, most of this innovation came from adding variable annuity living benefit riders, such as guaranteed minimum income benefits and guaranteed lifetime withdrawal benefits. These products have the advantage of providing income protection and investment flexibility. In 2008, contingent deferred annuities (CDAs) were introduced to the market as a way to isolate the longevity risk protection. Their benefits are similar to variable annuities with guaranteed lifetime withdrawal benefits as they provide protection against outliving ones assets.
As the longevity risk market continues to innovate and develop new products, insurance regulators are evaluating the adequacy of the current regulatory framework in place to govern these products. In 2013, the NAIC established CDAs as an annuity product best sold by life insurance companies. In addition, Joint Forum released its final consolidated report, Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks, on the potential for contagion issues in the longevity market.
On the federal front, the U.S. Department of the Treasury and the Internal Revenue Service issued final rules regarding longevity annuities on July 1, 2014. These rules amend the required minimum distribution regulations so that longevity annuity payments will not need to begin prematurely in order to comply with those regulations. The change was designed to encourage increased investment in guaranteed lifetime income protection insurance products.
In 2015, insurance regulators continued working through the various pertinent NAIC committees and groups to evaluate existing regulations on reserving, solvency, regulatory authority, and consumer protections. To facilitate discussion on this topic, CIPR hosted a half-day and-a-day symposium, Boom or Bust? A Look into Retirement Issues Facing Baby Boomers, on Monday, June 15, 2015 in Kansas City, Mo. The symposium covered a variety of financial and insurance related topics related to aging adults, including the impact of longevity on pre-retirement and post-retirement planning.
In 2016, state insurance regulators, through the NAIC, completed its review of CDA-related issues and adopted CDA-related revisions to several NAIC model acts. They also completed a guidance document that serves as a reference for states on CDA-related issues.