Unpredictable Life, Predictable Expectancy? The Impact of Future Longevity Improvements on Pension Fund Investment Strategy

Abstract

Managing longevity exposure continues to be one of the greatest challenges facing defined benefit (DB) pension funds, but the size of transactions undertaken to explicitly hedge this risk remains small compared to the total risk.

This article focuses on quantifying longevity risk, with a particular focus on doing so in a way that generates actionable outcomes for investment strategy. For the first time, we focus explicitly on the impact of changes in future longevity improvements, and we express risk in terms of its potential impact on a scheme’s Required Return objective, and therefore on investment strategy. We also analyze the impact of increased longevity improvements on the efficiency of interest rate and inflation hedges a scheme may have in place.

We present the results of three relevant case studies : an underfunded scheme with the goal of full funding over ten years; a full funded scheme running a terminal portfolio; an underfunded scheme considering a partial buyout.