“Longevity Risk and Retirement Savings”
Abstract
Over the last couple of decades there have been unprecedented, and to some extent unexpected, increases in life expectancy which have raised important questions for retirement savings. We study optimal consumption and saving choices in a life-cycle model, in which we allow for changes in the distribution of survival probabilities, according to the Lee-Carter (1992) model.
We allow individuals to hedge longevity risk through an endogenous retirement decision and by investing in financial assets designed to hedge this risk. We find that the welfare gains of investing in these assets are substantial when longevity risk is calibrated to match the forward-looking projections of the US Social Security Administration and the UK Government Actuaries Department. These gains are particularly large in a context of declining benefits in defined benefit pension plans. Finally, we draw implications for optimal security design.