I am a firm believer in “you can’t get something for nothing.” So it is when a new derivative is proposed. Either there are natural counterparties to take up the exposure (reducing their risk), or speculators must be encouraged to take the risk (more likely).
So, with longevity derivatives, the risk is people living too long leading to more pension payments in future years. The proposition is: find a party that is willing to make more payments if mortality is better than expected, and offer him a payment, or series of payments, as an inducement to enter the transaction.
Let’s think for a moment, what entities benefit from a rise in longevity? I can think of one: life insurers. But there is a problem: anti-selection. People who buy life insurance tend to be sicker than those of the general population, who tend to be sicker than annuitants. Annuitants live the longest, and their lifespans improve the most on average. Life insurers would find taking on longevity risk to be a dirty hedge at best for their life insurance books. In general there have been few reinsurance agreements for longevity risk for immediate annuity portfolios, but then, that would be a really small component of the life insurance industry at present.
Even when terminal funding was permitted (back in the 1980s to early 90s) — where plan sponsors could buy annuities from insurers to