Mon, May 02, 2005 - Page 9 News List

Longer lives mean more problems with pensions

By Robert Shiller

BNP Paribas hoped to place the bonds with? UK pension funds, but so far the issue has not been fully subscribed. Most of the likely buyers are slow to make up their minds, since trustees, fund managers, consultants, and employer sponsors must all become comfortable that the new concept is consistent with their fiduciary obligations. Moreover, it is not clear that the EIB can get further help from reinsurers in managing the risks it assumes by issuing such bonds because reinsurers do not yet see how they can fully hedge the risks involved.

The slow launch of longevity bonds ultimately reflects a fundamental question: can we genuinely reduce the impact of longevity risk? If everyone is affected by longevity risk in the same way, then no matter what the price of a longevity bond, everyone should logically want to be on the same side of the contracts -- all buyers at one price, all issuers at another. No difference means no market.

But, in fact, we are not all affected by longevity risk in the same way. Life insurance companies, drug firms, businesses providing services for the elderly, and investors in retirement real estate would all benefit from increased longevity, while defined-benefit pension plans and annuity providers would lose. Less affluent individuals are also more threatened by longevity than those for whom living longer mainly means leaving a smaller inheritance to their children. Indeed, countries with higher birth rates are less exposed to longevity risk in the next half-century or so than countries with low birth rates.

We thus need a large and liquid market for longevity risk so that these different groups can creatively share their risks with each other. In fact, creating such a market is the most important step we can take to address longevity risk, for we could then discover its true price, allowing myriad business decisions involving longevity to be made more efficiently.

There is virtually no history of the price behavior of longevity bonds, so discovering their buyers and sellers, and the prices that clear the market, will take some time. But longevity bonds, while only experimental today, will eventually become vitally important to the world economy.

Robert Shiller is professor of economics at Yale University, director at Macro Securities Research LLC and author of Irrational Exuberance and The New Financial Order: Risk in the 21st Century.

Copyright: Project Syndicate

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