The Uncertainty of Human Life Expectancy and Its Impact on the Insurance Industry

The demographic change (mainly caused by low birth rates and an increase in life expectancy) severely impacts Pay-as-you-go (PAYG) Pension Systems. In countries where necessary reforms of such systems have not been implemented in due time, replacement levels of such systems are likely to be reduced. As a consequence, the importance of individual retirement savings will increase: An ever-larger amount of money from individual retirement savings will be required to finance the desired standard of living (as opposed to expenses above and beyond the desired standard of living). Since financing the standard of living largely means expenses that occur regularly until death (and since nobody can know who long they will live), the importance of lifelong annuities is likely to increase in many markets.
While the so-called unsystematic longevity risk (some people die before and others after their life expectancy) is diversifiable, the so-called systematic longevity risk (life expectancy in the population increases at a stronger pace than anticipated) is not. We argue that the uncertainty with respect to the future development of human life expectancy is currently particularly high (e.g. due to progress with respect to a potential modification of the fundamental biology of aging). We present some recent research in this respect and conclude that understanding, modelling, measuring and managing the resulting risk needs more attention from annuity providers. We close with some potential alternative approaches to manage this risk (by product design or hedging).