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ABSTRACT
One of the key problems facing annuity providers is mortality risk, the risk of underestimating mortality improvements. The authors argue that the government could help the issuers of annuities to hedge aggregate mortality risk by introducing a new type of bond, which the authors call a survivor bond. The future coupons on this bond depend on the percentage of the population of retirement age on the issue date who are still alive on the future coupon payment dates. The coupons on the bond therefore decline over time but continue in payment until the last members of this population cohort have died. The government would therefore be assuming a risk that has hitherto been borne by the private sector. However, governments now issue inflation-indexed bonds, and the authors would argue that inflation risk is a much greater risk than mortality risk in aggregate. Furthermore, governments directly contribute to mortality risk: for example, they promote public health campaigns that, if successful, lead to mortality improvements that are difficult to predict many years ahead. Survivor bonds enable pension provision to be a shared responsibility between the public and private sectors.
INTRODUCTION
Governments throughout the world are reviewing their pension systems with a view to improving the arrangements for those who are poorly served by existing systems. However, the debate to date has focused almost exclusively on the accumulation stage, the period of active membership of a pension plan up until the retirement date. Issues here include the advantages and disadvantages of funding versus pay-as-yougo (PAYG), defined benefit versus defined contribution, and active versus passive fund management.1
What has received much less attention is the retirement stage. This lack of focus on retirement issues should not be surprising. When a new plan is established, the retirement stage is typically 40 years or more ahead. Furthermore, for members of defined benefit plans (whether public sector or private sector, funded or unfunded), someone else apart from the plan member is guaranteeing or at least promising to deliver a particular level of pension in retirement. However, this is not the case with defined contribution (DC) plans, and most new plans being established throughout the world are DC plans. With DC plans, there is no guaranteed pension at retirement....