Integrating longevity risk, macroeconomic fluctuations, and financial risk: A VAR approach

The uncertainty in future mortality trends, i.e. the longevity risk,can cause substantial problems for the pension and insurance industry.This paper proposes to forecast the distribution of future mortalityrate jointly with variables related to macroeconomic conditions and financial market variations by a vector autoregressive(VAR) model. Themethod is illustrated by empirical implementations based on U.S datafrom 1970 to 2007. Based on the empirical results, two numerical examples are analyzed to asses the importance of longevity risk. Firstly, I investigate the effects of raising retirement age on the fair premiums needed for a pension policy and I find a substantial tradeoff between the two values. Next, I examine the impact of longevity risk on the funding ratio uncertainty. The results show that while the micro-longevity risk vanishes for funds of large size, the macro-longevity risk still remains, although its role becomes less important when financial market risk is introduced.