What is Survivor Bond?
A survivor bond is a type of fixed-income security in which future coupon payouts are based on the percentage of a defined population group who are alive on the stated payment dates.
- Survivor bond is a a type of fixed-income security in which future coupon payouts are based on the percentage of a defined population group who are alive on the stated payment dates.
- Coupon payments from a survivor bond steadily decline until the last member of the group has died.
- Survivor bonds exist as a way to hedge longevity risk, which is the risk that a pension fund or plan makes incorrect assumptions about longevity risk, mortality rates, and future cash flow needs.
Understanding Survivor Bond
A survivor bond's payments, or coupon, is determined by the remaining survivors of an initial group. The payouts of these coupons are dependent on the proportion of the group that survives to a certain age.
The idea of longevity risk is the reason why survivor bonds exist. Longevity risk applies to pension funds or life insurance companies that may have exposure to higher-than-anticipated payouts due to improving life expectancies. These unplanned, higher payouts due to an aging population can place stress on the fund's cash flow needs.
The term longevity risk refers to the risk of loss sustained by an unanticipated reduction in mortality rates and a corresponding increase in longevity. In simple terms, that means that people benefiting from a particular plan or payout may live longer than expected and defy some of the assumptions made at the time the plan was put in place.
Survivor bonds, as part of a risk management strategy, help to mitigate extended payout schedules. Risk management happens as a fund manager analyzes the potential losses and takes action to lessen the impact on the fund's overall revenue. Survivor bonds are used by annuity providers and pension plan managers to hedge aggregate longevity risk. As mortality increases and the group of survivors decrease over time, coupon payments from the bond will decline until they eventually reach zero.
Survivor Bonds Special Considerations
While advances in health care and medicine have led to sustained increases in life expectancy over the years, aging populations are putting severe financial pressure on government pension plans around the world. Survivor bonds help annuity providers and pension plans hedge this risk since these bonds are ideal for matching their liabilities in the presence of longevity risk.
Longevity and mortality risk are sometimes used interchangeably, and can often mean the same thing. However, mortality risk can also be a way to express the idea that a plan participant can die at any time, whether it be sooner or later than statistically expected. This combination of longevity risk and mortality risk presents a level of considerable uncertainty to the operation of these plans, and can make it difficult to predict their total payments, or how long that period of payments may last.
The overall trend in the United States and other Western countries is that life expectancies have been steadily growing. The fact that people enjoy longer lives would generally be a good thing, but it can be problematic for pension plans such as Social Security. Managers and annuity providers need to adjust their payout expectations and alter their financial strategy to accommodate this extended period of payouts, which may be longer than anticipated.