Longevity risk

A retirement plan has to assume a date of death. Longevity risk is the risk that the assumption is too early.

The workbook calls it the biggest risk to the retirement goal. It is not a market risk and cannot be diversified away: it comes from the plan itself. Underestimate the years in retirement and the corpus is simply too small, however well it is invested.

Who carries it depends on the scheme. Defined benefit plans protected the member — the employer paid for as long as the member lived. In a defined contribution plan such as the NPS, the subscriber assumes it, together with investment risk.

Why it is growing. Life expectancy at birth in India rose from 58 years in 1990 to 72 years in 2024 (World Bank, as cited in Chapter 1), driven by better diet, health care and lifestyles. Chapter 1, section 1.3, notes that the period in retirement may be anywhere between 20 and 25 years.

Where it enters the arithmetic. The corpus calculation in Chapter 3 has four variables — periodic income, inflation, the corpus return, and the period of retirement. Longevity risk is an error in the fourth one.

Responses by stage (Chapter 3, section 3.5.1, and Chapter 7):

Guaranteed lifetime income — an annuity for life — is the product that transfers the risk to an insurer.

Chapter 3's worked example for Rani computes the corpus needed at 60 for an inflation-adjusted monthly income of Rs 1,50,215 over 20 years, at an inflation-adjusted return of 1.89 per cent a year with payments at the beginning of each month:

PV(1.89%/12, 240, −1,50,215, 0, 1) = Rs 3,00,48,832

That corpus is exhausted at 80. Keep every input the same and change only the years:

Ten more years of life costs about Rs 1.13 crore more in corpus — an increase of about 37.5 per cent from a change in one assumption.

Now run it the other way. Rani builds the Rs 3.00 crore corpus and lives to 90. From 80 onward she has no retirement income at all, which is precisely the outcome the workbook describes: reducing the standard of living or seeking alternate income so the corpus is not drained before the end of life.

Chapter 1 introduces longevity risk in section 1.1.1 (the shift from DB to DC) and section 1.1.4 (Increasing Life Expectancy), and its sample questions ask what life expectancy directly affects — the period in retirement. Chapter 3 treats it in section 3.2.3 (Time Horizon) and section 3.5.1 (Underestimating Retirement Needs). Chapter 7 opens its Protection Strategies by calling longevity the biggest risk, and lists income security and protection from longevity among the features of retirement income. Expect questions on who bears the risk in DB versus DC plans and on which products manage it.

• DB plans protect against it; DC plans shift it to the individual. The NPS is DC.
• Life expectancy affects the period in retirement, not monthly expenses or returns — the Chapter 1 sample question.
• Longevity risk is not inflation risk, though Chapter 7 names inflation as the second risk needing close attention. One stretches the period; the other raises the income needed each year.
• The pre-retirement stage is the best time to address it; mid and late retirement the most difficult.
• The deferred annuity is the product response, the reverse mortgage the late-stage asset response.
• Rising average life expectancy is a population statistic. For an individual plan the workbook says also to weigh gender, health, genetics and lifestyle.