The economics of sharing macro-longevity risk

Pension funds face macro-longevity risk or uncertainty about future mortality rates. We analyze macro-longevity risk sharing between cohorts in a pension scheme as a risk management tool. We show that the optimal risk-sharing rule and the welfare gains from risk sharing largely depend on the retirement age policy. In case of a fixed retirement age welfare gains from sharing macro-longevity risk measured on a 10-year horizon are between 0.1 and 0.3 percent of certainty equivalent consumption after retirement for each cohort. By contrast, if the retirement age is fully linked to changes in life expectancy, welfare gains are substantially higher. In this case the risk bearing capacity of workers is particularly large because their labor supply acts as a hedge against macro-longevity risk. As a result, workers absorb risk from retirees in the optimal risk-sharing rule, thereby increasing the welfare gain for each cohort up to 1.8 percent in the Lee-Carter mortality model and up to 2.9 percent in the Cairns-Blake-Dowd model.