What is a Survivor Bond
A survivor bond is a type of security whose future coupons have a basis on the percentage of a stated population group who are still alive on the future coupon payment dates. In other words, the remaining survivors of that group.
The payouts of these coupons are dependent on the proportion of the group that survives to a certain age.
BREAKING DOWN Survivor Bond
The basis behind survivor bonds is the idea of longevity risk. Longevity risk applies to pension funds or life insurance companies who may have exposure to higher than anticipated payouts due to improving life expectancy. These unplanned, higher payouts could place stress on the company's revenue stream. 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 benefitting from a particular plan or payout may live longer than expected.
These bonds, as part of a risk management strategy, helps 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 overall fund's 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 into the pension or insurance plan will decline until they eventually reach zero.
Extended Life Expectancy and Survivor Bonds
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 that be later than statistically expected or sooner. 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 are enjoying 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.