Innovative Financial Products
for an Aging World

Presentation for the Japan Life Insurance Forum, Tokyo 2019

Olivia S. Mitchell

mitchelo@wharton.upenn.edu
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Risk Management for an Aging WorldKey risks of aging:• Poor healthWe must do more to: Identify the risks; Mitigate the risks; Finance/insure
the risks.

(dementia, frailty)• Longevity(outliving assets)• Asset price risk
(housing, investments)• Political risk(taxes, transfers)• Global risk
(epidemics, capital marketshocks, longevity shocks)2

At the Core: Financial illiteracy iswidespread! The “Big Three” (Lusardi/Mitchell)Interest Rate: Let’s say you have $100 in a saving account paying
2% interest/year. How much would you have in the account at theend of 5 years? <$102; =$102, >$102
Inflation: Imagine that the interest rate on your savings accountwas 1% per year and inflation was 2% per year. After 1 year, withthe money in this account, would you be able to buy: > today, = today;< today

Risk Diversification: True or false? Buying a single company stock
usually provides a safer return than a stock mutual fund.

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International Comparisons (% correct)

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Poor health• Longitudinal nationally representative surveys of older persons arekey. US Health & Retirement Study http://hrsonline.isr.umich.edu/• Dementia: Fishman followed healthy people at age 70 to end of theirlives.
Found 27-31% of men, 35-37% of women developed dementia before death.
Yet delaying dementia 5 years would cut prob. of ever getting dementia.
[exercise, diet, BP, avoid smoking & obesity]• Nursing home stays: Hurd et al. followed people age 57-61 to end oflife.
Over half (56%) ever in a nursing home; 64% of women, 51% of men. Much
higher than thought previously (~1/3).
Better monitoring, care coordination, rehab, home care, exercise.
5Longevity Risk with Systematic Mortality Shocks

t-Period Survival Probability at Age 20 (tp20)

10.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
00

10

20

30

4050
t60

70

80

90

100

Notes: Simulated distribution of age-20 female t-period survival probabilities (99%:1%)
based on CBD (2006b) mortality model (10,000 simulations). Darker areas represent
higher probability mass. Horneff et al. IME 20156

Annuity Innovations:• Variable Annuities- Allows portfolio changes after retirement• Two-tier Annuities• Pays out more if need nursing care (3+ ADLs)• Deferred Annuity- Recommended for defined contribution plans• Tontines- Systematic shocks remain with risk pool.
“Issuer makes known fixed payments (the numerator), …distributed among the survivors (the denominator).
[S]yndicate incurs aggregate longevity risk…(which) reduces the need for capital (if it was an insurancecompany) and …increases the expected payout per survivor. Milevsky (2017)7

“Putting pensions back” into DC plans very valuable• Optimally put 5-15% ofplan balance @65 into LIA(pays from age 85).
• Pretty good default:10%>$65K, results verysimilar!

• Welfare gains worth 614% of retirement accruals(w/ ave. mortality).
•Appealing to wide set ofretirees.

Horneff et al. 2018.

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Asset price risk
• Reverse mortgages: let people access net equityin their homes• Home price insurance tied to home price index:Shiller• Longer-duration indexed bonds: Needed forprice-indexed annuities

9In this time of turmoil: what about guarantees
on investments?
Various guarantee formats:Principal guarantee
Minimum ROR (or return band)Minimum Benefit
Ex: Japan, Germany, Chile (range), Mexico
Yet BEWARE: Guarantees can be costly! (% ofcontribution over 40 years)• Principal Guarantee (0% ROR)
~0%
• Bond Return Guarantee
16-25%
Lachance/Mitchell 2002; assumes 50/50 stock/bond portfolio held for 40 yrs10

And Political Risk is Growing!
• Humanitarian crises;• Populism/religious violence;• Nuclear threats;• Brexit/Ukraine;• Deficit spending;• Isolationism/protectionism/tariffs/anti-migration sentiment.

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Global Risk: Epidemics, global asset
meltdown, population-wide survival shocks?
• Risks mostly inherently undiversifiable!
• Catastrophe bonds may work across nations andregions.
• PAYGO? This creates other risks in times of low fertility
and long lived elderly.

12Implications: Mitigating/financing old age risks• Poor health: invest in health, financial literacy.
• Longevity risk: annuities, tontines.
• Asset risk: longer duration financial instruments,
better securitization• Political risk: very difficult!

• Global risk: Cat bonds to manage epidemics,
financial market crashes
Better products to mitigate & financeretirement risk;
Better partnership for an aging world.
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Thank you!
• For more information:
Wharton’s Pension Research Council:• http://www.pensionresearchcouncil.org/

Books and working papers:• http://www.pensionresearchcouncil.org/publications/books.php

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