QIS: Longevity Risk Sharing

In a recent discussion about the future and fundamentals of the Dutch pension system I discussed the importance of solidarity.

As expected, the participants quickly came up with the various forms of solidarity, including solidarity between:

– higher and less educated people

– women and men

– old versus young people

Longevity Risk Sharing

Remarkably non of the participants had any idea about the financial impact of one of the most fundamental forms of risk sharing in case of a life annuity: Longevity Risk Sharing. Let's call it in general 'mortality solidarity'.

When asked, most participants strongly underestimated the impact of mortality (mortality share) as part of the yearly payment in the form of a life annuity. On the other hand, they overestimated the impact of 'return'.

Some of the participants had the idea that they would be 'better of' with a traditional individual investment plan in combination with a little more investment risk (and return) ...

Life Annuity Composition
So let's do a mini QIS (Quantitative Impact Study) of 'mortality solidarity' by examining the development of the composition of an annual lifetime annuity, regarding three basic elements: Mortality, Return and Desaving.

Here is the result for a Dutch man, age 65, with a lifetime annuity based on an average 5% yearly return:

Translated in table form:

	Yearly Payment Composition				Cumulative Composition
Age	Mortality	Return	Desaving		Mortality	Return	Desaving
65	16%	51%	33%		16%	51%	33%
66	17%	50%	34%		16%	50%	34%
67	18%	48%	34%		17%	50%	34%
68	19%	46%	34%		17%	49%	34%
69	21%	45%	35%		18%	48%	34%
70	22%	43%	35%		19%	47%	34%
71	24%	41%	35%		20%	46%	34%
72	26%	39%	35%		20%	45%	34%
73	28%	38%	35%		21%	45%	34%
74	30%	36%	34%		22%	44%	34%
75	32%	34%	34%		23%	43%	34%
76	34%	33%	33%		24%	42%	34%
77	36%	31%	33%		25%	41%	34%
78	38%	30%	32%		26%	40%	34%
79	41%	28%	31%		27%	40%	34%
80	43%	27%	30%		28%	39%	34%
81	45%	25%	29%		29%	38%	33%
82	48%	24%	29%		30%	37%	33%
83	50%	22%	28%		31%	36%	33%
84	52%	21%	27%		32%	36%	32%
85	55%	20%	26%		33%	35%	32%
86	57%	18%	25%		34%	34%	32%
87	60%	17%	23%		35%	33%	31%
88	62%	16%	22%		36%	33%	31%
89	65%	15%	20%		37%	32%	31%
90	67%	14%	19%		39%	31%	30%
91	69%	13%	17%		40%	31%	30%
92	72%	13%	16%		41%	30%	29%
93	73%	12%	15%		42%	29%	29%
94	75%	11%	14%		43%	29%	28%
95	77%	11%	12%		44%	28%	28%
96	78%	10%	12%		45%	28%	27%
97	79%	9%	11%		46%	27%	27%
98	80%	9%	11%		47%	26%	26%
99	82%	8%	10%		48%	26%	26%
100	83%	8%	10%		49%	25%	25%
101	84%	7%	9%		50%	25%	25%
102	85%	7%	9%		51%	25%	24%
103	85%	7%	8%		52%	24%	24%
104	86%	6%	8%		53%	24%	24%
105	87%	6%	7%		54%	23%	23%

Observations

As is clear from the table above :

• Already at the start the start of the annuity, at age 65, 16% of the yearly payment is due to mortality risk sharing and 'only'  51% is related to the 'return'.
• As a pension member continues to live, the  'mortality share' of the annual payment increases. At the age of 83 already 50% of his annuity is due to mortality effects and the 'return share'  is already down to 22%.
• As from age 77 of, the 'mortality effect' on the annual payment exceeds the 'return effect'.
  
  

Conclusion

From some simple calculations, we can conclude that longevity (mortality) solidarity is a fundamental part of a life annuity.
 

AfterMath

Make your calculations with other interest rates, ages or life tables with the Pension Calculator (Excel).

You may download the pension calculator HERE

Links/Sources

- Solidarity: Sticking together or ..(Google Books, P. de Beer)

- Benefit of collective schemes (IPE)

- HFC: Pension Challenge

- Download the Excel Pension Calculator

Global Country Perspective

Do you find it - just like me - hard to get a clear picture of a country's impact and contribution from global perspective? Here's some help...

GCI
The Global Competitiveness Index (GCI) is a comprehensive tool that measures the microeconomic and macroeconomic foundations of national competitiveness. It is composed of 12 "pillars", or categories.

Competitiveness is the set of institutions, factors and policies that determine the level of productivity of a country taking into account its level of development.

Charts

With the help of the free Tableau (visual) software I've created several charts that give an rough idea of a country's competitiveness an productivity in relation with it's relative global size (% of total world GDP).

The last rectangle chart 'Country GDP world Share' shows in a scaled way the GDP proportions of all 148 measured countries in the world. The color of each rectangle represents the GCI-level of each country (dark red=poor, dark green = splendid).

Remarks

If you look specifically for the Netherlands in the first chart.... Click (or double click) on the word 'Netherlands'. In general, move you mouse across the different circles and rectangles to view more detailed information.

Enjoy!

Source World Economic Forum,

The Global Competitiveness Report 2013-2014

Base period 2013-2014

Learn About Tableau

Test: Rational Thinking in a Crisis

End October 2007 my wife and I were flying from New York to San Diego. Due to an overheated engine our Captain took the one and only right decision: an emergency landing (at Chicago). Thankfully, a successful emergency landing.

Although - for a split second - we were disappointed that we would not arrive at San Diego that night, we immediately realized that our goal was no longer arriving at time, but surviving!

 How do we respond in crises situations? Take the next simple test to find out.

Original Source: Risk & Return