Longevity Risk in Notional Defined Contribution Pension Schemes: A Solution

• Published in: Geneva papers on risk and insurance. Issues and practice 2016-01, Vol.41 (1), p.24-52
• Main Authors: Arnold (-Gaille), Séverine, del Carmen Boado-Penas, María, Godínez-Olivares, Humberto
• Format: Article
• Language: English
• Subjects: Age; Analysis; Death benefits; Defined contribution plans; Economic development; Economics and Finance; Expected values; Finance; Hedging; Insurance; Interest rates; Life expectancy; Life insurance; Mortality; Original Article; Pension plans; Present value; Reinsurance; Retirement; Retirement planning; Risk Management; Solvency; Studies
• ISSN: 1018-5895; 1468-0440
• DOI: 10.1057/gpp.2015.15

Notional defined contribution pension schemes (NDCs) aim at reproducing the logic of a financial defined contribution plan under a pay-as-you-go framework. Of particular interest is how the accumulated capital of a deceased person is used when the death occurs prior to retirement. While in most countries this accumulated capital (called survivor dividend, SD) is kept by the scheme, in Sweden it is distributed among the same cohort survivors. This paper aims to analyse to what extent the SD kept by most NDCs can be used to cover an unexpected longevity increase. We develop formulas under different assumptions (constant or according to Lee—Carter mortality improvements) to calculate the maximum mortality decrease a scheme can cover if the SD is not distributed. We also apply the formulas using Polish, Latvian and Swedish life tables and show that the non-distribution of the SD is a potential solution to cover the longevity risk of NDCs.