Can someone explain to me the non-market longevity risk under the liability relative approach. It says the risk is a mortality risk, but I don’t understand what that means. What is the risk of a beneficiary dying from the perspective of a DB sponsor? If they die wouldn’t the payments just be the same, but flowing through to that individual’s beneficiaries?
Thanks for any clarification as to what longevity risk means in this context.
I believe that they’re referring to the possibility of a plan participant having a longer lifespan than the pension plan had projected - thus, the liability is higher than expected.
Longevity risk is a risk of individual that he or she may live longer than her/his source of financing. However, there are some non-market risks from the perspective of DB plan and is called Liability Noise. It is referred to actuarial assumptions about demographic trends so by that point of view, mortality and longevity risk may affect long term planning and optimal funded status. Eg. If demographic trends are quite volatile, mortality rates changes frequently, it is difficult to estimate future liabilities from the perspective of Plan sponsor.
@ PewPew It’s a defined benefit, not an annuity. They get paid until their accrued benefit is gone, not until they die.
@Flashback, I understand how there is a risk to modeling mortality for active participants, as they may be projected to work another 15 or so years, and then unexpectedly pass away, thus resulting in a smaller future liability, but how is there a mortality risk for retirees and deferreds?
Mortality risk or Longevity risk may affect ALM portfolio management if based on incorrect or rapidly changed mortality/longevity assumption. Also it may affect DB portfolio duration. Thus it would also affect payout for all kind of participants. That’s how I see this issue. Such risks are very difficult to hedge.
Retirement payments out of a DB plan are typically life contingent: as long as you’re alive, you get paid. You can add a guarantee period to hedge against early death.
“It’s a defined benefit, not an annuity. They get paid until their accrued benefit is gone, not until they die.” Again - this is not true which is probably causing your confusion here. The short and easy answer is if a participant lives longer than projected you will end up paying more - a large risk for DB plans.
Now the higher level points as it relates to ALM are that when you estimate duration for a DB plans liabilities you have to make an actuarial assumption on age of death. The risk is that this age of death does not actually pan out for the plan, thus if you structure a portfolio to have a duration of plan assets = duration of plan liabilities then the risk is that the duration of plan liabilities is not what you project thus you actually have a duration mismatch leading to more volatility of surplus, etc.
If you look at a mortality table and it says the participants will live to age 85 - you have a 50/50 shot that this will be accurate. Half the time they will die before/half the time they will die after. If they live longer than age 85 (i.e. liability duration is higher than projected) yet you structured the portfolio to match the duration of an assumed age of death of 85 then if rates fall you will suffer as liabilities will rise at a greater rate than the assets (surplus will be lower). I think this is the point they are getting at but don’t exactly know where you are point to in the text.
thanks guys, I misunderstood. Maybe I should revisit the L2 curriculum cause apparently I don’t understand DB lol.