Longevity, Systemic Models and Business Risk

3. The four-pillars model
Starting from that systemic model, the fact which comes out can be summarised by a slogan: ‘the third pillar needs the fourth’.
If it is true that the insurance system, also from the historical viewpoint, in commercial terms seems to be the obvious interface for customers to meet their longevity needs and the natural bearer of the risk, as already hinted at, this does not automatically mean that this risk can and should be fully borne by the insurance or reinsurance system.
There are three main reasons:
• the ‘non pooling’ nature of the longevity risk: the increase of the portfolio and the dispersion of the risk over a large number of individuals does not reduce the risk impact;
• the tendentially catastrophic risk size;
• the widespread indifference by players — both insurance and reinsurance companies — to taking on the risk.
That approach seems to be vital also at tactical and political level, because it helps insurance players to avoid the (instrumental) allegation of simply playing for position.
Like the three pillars model, where financing the system, increasingly requires that the incomes of individuals working beyond the age of 60 can and must be integrated into it so also in managing payment rates, the ‘three-protection-shields’ model must be complemented by the fourth shield: the ‘rest of the world’, which takes on part of the current risk and is rewarded through the most dynamic and flexible allocation mechanism ever invented and gradually implemented by mankind: the financial market.
This is certainly not an easy task and perhaps attributing the relevant accountability is difficult14: the optimism of the will, although always necessary, is often opposed by the pessimism of the mind. In general however, we feel that the reasons used for opposing this approach have more the whiff of a brake on the action than binding chains, as will be explained in the last paragraph below. Finally, it is worth highlighting which players I consider unfit for the role of additional ‘pillars’ in the management of the longevity risk: pension funds and industrial businesses.
As far as pension funds are concerned, my statement is apparently counter-intuitive, but it is based on the fact that, since pension funds do not have their own assets and since their assets and liabilities are dynamically identical, they do not have the necessary resources to cover unexpected — but possible — losses.
A pension fund taking on the longevity risk, in particular according to the defined contribution model but also simply in the distribution stage of defined contribution plans, runs the risk of ‘getting stuck’ in conflicts which, for example, in Italy eventually led to the well-known destiny of the glorious pension fund of the employees of Comit (an Italian bank).
The Italian legal system ruled on that limit (article 6 of the new single text on complementary social security): even though it allows pension funds to directly manage the payment stage, in the final analysis it considers it a residual hypothesis subject to strict control.
A fortiori we can say that neither are industrial businesses natural bearers of the longevity risk. To begin with, they are not familiar with the risk, do not have — nor are they encouraged to develop — the necessary risk management approach to run it, do not have their own allocated ad hoc capital and, finally, their wage policy would be strongly influenced by it, since future contributions are the only possible form of adjustment.
The case of defined contribution schemes in the British market described by David Miles15 really seems to be illuminating and final.
According to recent data provided by KPMG in the UK, a one-year increase in the average life expectancy of all employees will entail additional costs amounting to 20 billion Pounds for pension liabilities. Italian law learned the lesson and virtually does not envisage defined contribution schemes, with the exception of those designed for self-employed workers.
Businesses are not natural bearers of the longevity risk because their financial flexibility is limited, even very limited in an age of competitive globalisation: they cannot translate actuarial deficits into an increase in the cost of labour, nor can the cost of labour be easily lessened through the reduction of contributions in order to balance the defined contribution fund.

14 Since this is a general interest, I obviously believe that first of all the politicians must do their part – although this is further complicated by the undeniably international nature of the issue.
15 See the article by David Miles dated 31-1-2005 available on the website la

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