The Impact of Mortality Projection Models in case of Flexible Retirement Schemes

The trend of mortality is uncertain and this uncertainty causes the so called Longevity Risk. This risk has become one of the key risks that Governments need to manage, not only in the context of welfare policies but also as regards the national Social Security System. The longevity risk from an individual point of view represents the risk that individual mortality rates differ from the expected ones. From an aggregate point of view it represents the risk that unexpected lifestyle changes or medical progress can improve longevity. We can refer to the last one as Trend risk, which has the nature of a systematic risk. Therefore it is not diversifiable and represents a crucial risk component in Social Security Systems management, as well as in pension funds and annuity provider’s risk management processes. In this context, many countries have set up Social Security Systems which link retirement age and/or pension benefits to life expectancy, considering a mechanism for indexing the retirement age and/or pension benefits. The issue is a subject of great interest in recent literature; the debate outlines new directions in pension scheme developments and presents experiences with flexible pension schemes from various countries. In this context, we consider an indexing mechanism based on the expected residual life expectancy to adjust the retirement age and keep a constant Expected Pension Period (EPP). The motivation is to focus on the recent and spread need to create flexible retirement schemes for facing global ageing and the prolonging working lives. We compare the costs of the Social Security System in case of a retirement age set at a certain age (traditional system) and the costs in the case of the indexed retirement age. In this paper we evaluate the impact on those costs of different selected mortality rates projection models. Empirical evidences are provided.