The political economy of government-issued longevity bonds

This article explores the trade-offs associated with government issuance of longevity bonds as a way of stimulating private annuity supply in the presence of aggregate mortality risk. We provide new calculations suggesting a 5 percent chance that aggregate mortality risk could ex post raise annuity costs for private insurers by as much as 5-10 percentage points, with the most likely effect based on historical patterns toward the lower end of that range. While we suspect that aggregate mortality risk does exert some upward pressure on annuity prices, evidence from private market pricing suggests that, to the extent that private insurers are accurately pricing this risk, the effect is less than 5 percentage points. We discuss ways that the private market can spread this risk, while emphasizing that the government has the unique ability to spread aggregate risk across generations. We note factors that might hamper such an efficient allocation of risk, including potential political incentives for the government to shift more than the optimal amount of risk onto future generations, and the possibility that government fiscal policy might allocate risk less efficiently within each generation than would private markets. We also discuss how large-scale longevity bond issuance might affect government borrowing costs, as well as political economy aspects of how the proceeds from such a bond issuance might be used.