ANALYSIS OF THE SURVIVAL OF PENSION

FUNDS DURING HYPERINFLATIONARY

PERIODS WITH PARTICULAR FOCUS ON
LONGEVITY RISK IN ZIMBABWE
A PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE
REQUIREMENTS
FOR THE BSC HONOURS DEGREE IN ACTUARIAL SCIENCE
IN THE FACULTY OF SCIENCE

By
TATENDA TAKAIDZA,R187972Q
SUPERVISOR:MR L.DHLIWAYO
UNIVERSITY OF ZIMBABWE
FACULTY OF SCIENCE
DEPARTMENT OF MATHEMATICS AND COMPUTATIONAL SCIENCES
JUNE 2022
I dedicate this to my family and friends for their support
that has brought me this far.

iii
Table of Contents

Table of Contents vi

List of Tables vii

List of Figures viii

0.1 Acknowledgement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x

1 Introduction 1
1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Background Information . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.3 Statement of the problem . . . . . . . . . . . . . . . . . . . . . . . . 3
1.4 Aims and Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.5 Significance of the study . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.6 Project Layout . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1.7 Chapter Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

2 Literature Review 6
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.2 Conceptual Framework . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.2.1 Pension Actuarial Process . . . . . . . . . . . . . . . . . . . . 6
2.2.2 Pension Schemes . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.2.3 Longevity Risks and Pensions . . . . . . . . . . . . . . . . . . 11
2.3 Valuation of Longevity Risk . . . . . . . . . . . . . . . . . . . . . . . 13
2.3.1 Solvency/Insurance Buy-out . . . . . . . . . . . . . . . . . . . 14
2.3.2 Self-Sufficiency . . . . . . . . . . . . . . . . . . . . . . . . . . 14
2.3.3 Accounting Valuation . . . . . . . . . . . . . . . . . . . . . . . 14
2.4 Role of Pension Funds . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2.5 Types of Pension Funds . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.5.1 Defined Benefit Schemes . . . . . . . . . . . . . . . . . . . . . 17
2.5.2 Defined Contribution Schemes . . . . . . . . . . . . . . . . . . 18

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 2.5.3 Hybrid Schemes . . . . . . . . . . . . . . . . . . . . . . . . . . 19
2.6 Empirical Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
2.6.1 Basis of Financial Developments . . . . . . . . . . . . . . . . . 20
2.6.2 Pay as you go Financial System . . . . . . . . . . . . . . . . . 21
2.6.3 General Average Premium System . . . . . . . . . . . . . . . 22
2.6.4 Terminal Funding System . . . . . . . . . . . . . . . . . . . . 23
2.6.5 Successive Control Periodic System . . . . . . . . . . . . . . . 23
2.6.6 Scaled Premium System . . . . . . . . . . . . . . . . . . . . . 25
2.7 Lognormal distribution . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2.8 Financial Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
2.9 Life Annuities and Assurances . . . . . . . . . . . . . . . . . . . . . . 29
2.10 Renshaw and Haberman Model . . . . . . . . . . . . . . . . . . . . . 31
2.11 Currie Age-Period-Cohort Model . . . . . . . . . . . . . . . . . . . . 31
2.12 P-Splines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
2.13 Cairns-Blake-Dowd 1 Model . . . . . . . . . . . . . . . . . . . . . . . 32
2.14 Funding of Occupational Pension . . . . . . . . . . . . . . . . . . . . 32
2.14.1 Individual Cost Method . . . . . . . . . . . . . . . . . . . . . 32
2.14.2 Accrued Benefits Costs . . . . . . . . . . . . . . . . . . . . . . 33
2.14.3 Entry Age Cost Method . . . . . . . . . . . . . . . . . . . . . 34
2.15 Chapter Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

3 Methodology 36
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
3.2 Data Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
3.3 Analytical Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.4 Descriptive Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.5 Analytical Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.6 Softwares to be used . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
3.7 Chapter Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

4 Data Analysis and Results 39

4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
4.2 Descriptive Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
4.3 Functional Demographic Model . . . . . . . . . . . . . . . . . . . . . 42
4.4 Projecting Death Rate . . . . . . . . . . . . . . . . . . . . . . . . . . 43
4.5 Life Expectancy Projection . . . . . . . . . . . . . . . . . . . . . . . . 44
4.6 Forecasting Accuracy . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
4.7 Forecast coherent functional demographic model . . . . . . . . . . . . 46
4.8 Lee Carter Mortality Tables . . . . . . . . . . . . . . . . . . . . . . . 48
4.9 Chapter Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

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5 Conclusions and Recommendations 53
5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
5.2 Discussion of the Findings . . . . . . . . . . . . . . . . . . . . . . . . 53
5.3 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
5.4 Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
5.5 Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

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List of Tables

vii
List of Figures

viii
Abstract
In this study, the consequences of hyperinflation on Zimbabwean pension planning
are examined, with an emphasis on longevity risk. A phenomenon known as hyperin-
flation occurs when prices for goods and services grow rapidly over time. Due to the
fact that the combined resources would not be sufficient for pensioners upon retire-
ment, hyperinflation has a detrimental influence on pension funds. Outliving their
retirement package, which would not have been adequate, will result in longevity
risk, i.e. living longer than they would have been provisioned for. This study looks
at how longevity risk, or the uncertainty of future mortality and life expectancy
results, affects the obligations of employer-provided defined benefit (DB) private pen-
sion plans. The study contends that a stochastic method to modeling mortality and
life expectancy is superior because it allows one to assign probabilities to various
forecasts, allowing for an adequate assessment of uncertainty and associated hazards.
The study offers the outcomes of estimating the Lee-Carter model for Zimbabwe in
this regard. By using Monte-Carlo simulations of the Lee-Carter model, it also de-
picts the uncertainty surrounding future mortality and life expectancy results. The
study explores the various strategies that private pension plans use in practice when
factoring longevity risk in their actuarial calculations in order to estimate the im-
pact of longevity risk on employer-provided DB pension plans. Sadly, the majority
of pension plans do not adequately take into consideration anticipated increases in
mortality and life expectancy. The range of the growth in the net present value of an-
nuity payments for a hypothetical DB pension fund is then estimated in the following
section of the study. Finally, the paper covers a number of policy concerns regarding
how to handle longevity risk, highlighting the necessity of an uniform strategy.

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0.1 Acknowledgement
I am aware of and deeply grateful to Mr Dhliwayo for volunteering to supervise me
and for devoting a significant amount of his time to reviewing and providing feedback
on the numerous scripts that resulted to the study document. Mr Dhliwayo’s encour-
aging words and helpful criticism inspired me to finish this dissertation despite the
extremely difficult circumstances. I would also like to express my gratitude to all of
the program lecturers who helped me develop the fortitude to endure.

THANK YOU!!!!

x
Chapter 1

Introduction

1.1 Introduction
The chapter will present background of the study and research problem statement on
survival of pension schemes during periods of hyperinflationary in Zimbabwe. The
chapter will also allude to the research aim and objectives. Significance of the study
will also be discussed with the need to expound how it will contribute to the re-
searcher, the university and community at large. The chapter will also establish the
project outline

1.2 Background Information

Applications for stochastic simulation models in life assurance insurance are signifi-
cant. They are utilized in pension liability estimation, portfolio management, asset
allocation, pricing, and offsetting of longevity-related products. The LINK model de-
veloped by Tillinghast Towers Perrin for actuarial usage globally is arguably the most
well-known stochastic model in the area of pensions. The majority of life and pension
companies are heavily exposed to mortality and longevity risk, even though the afore-
mentioned are risk factors related to the economy and finances. Additionally, this has

1
stimulated the active creation of stochastic mentioned features in recent years; yet, the
majority of models continue to be disassociated from the fiscal and operational risk
factors. A generic methodology for creating stochastic simulation models of the assets
and consistency liabilities of a common pension or life company in hyperinflationary
conditions is presented in this research paper. The primary asset classes utilized by
pension funds, including stocks, short- and long-term fixed-rate bonds, index-linked
bonds, and corporate bonds, are all taken into account by the framework, along with
longevity risk. Our models take into account the sometimes overlooked connections
between lifespan and the business; (Brace and Womersky, 2020). Such linkages are
crucial, for instance, in the assessment and hedging of liabilities and goods with long-
term lifespan links. Even weak statistical links in long-dated obligations may permit
partial hedges with substantial impacts on appraisals and risk management. Incor-
porating forecasts or user perspectives while maintaining consistency with statistical
parameter estimations is also possible using the modelling technique. This function
is essential in many circumstances when previous data does not provide the most
accurate forecast of the future. The current research study expands on a number
of past investigations on financial assets modeling that have been published in the
literature. The stochastic model takes into account statistical relationships between
economic growth and life expectancy. The linkages are used in this research work
to create a hyperinflationary complete liabilities simulation model, where the rela-
tionships influence returns across various asset classes. The variance decomposition
model for balanced portfolio returns, which uses just one or two risk components, ac-
curately describes returns even for enormous bond portfolios. This makes it possible
to create practical models for the returns on financial market investments, fixed-
rate governmental bonds, corporate bonds, and bonds that are indexed to inflation.
The study will also take into account the idiosyncratic potential losses on corporate
bonds, which was disregarded in past studies. The overall technique of (Buckle and

2
Womersky, 2020) is used for longevity, where mortality risks are characterized by
unique binomial risk factors that reflect annual fatalities together with interpretable
population-wide systemic risk variables. Doubling the length of a fund can reduce
idiosyncratic risk, but systemic risk is a lifetime risk that cannot be diversified away.
Because the idiosyncratic risk is explicitly included, the model is perfect for analyzing
the advantages of, say, merging or consolidating many pension funds. The validation
and assessment of the model are made easier by the natural interpretations that the
systemic risk variables permit. Compared to, say, the well-known Lee-Carter (1998)
theory and its improvements, in which the threats are calculated using a principal
components analysis that is not only challenging to read but also changes as scientific
models are supplied to the data, this is a significant benefit. Vector autoregressive
(VAR) models are used to simulate all important risk variables after appropriate
nonlinear adjustments. VAR models were suggested as an alternative to the cascade
structures in (Michaelson, and Mulholland, 2014). The VAR structure enables more
extensive connections between various risk variables. Additionally, VAR models are
well suited for fast vectorized calculations that enable the computer to quickly simu-
late millions of different situations. The ability to incorporate short-term projections
and/or long-term perspectives of the median values of the risk variables in the model
is a key benefit of the model calibration technique. Such arbitrary changes were also
suggested in (Michaelson, and Mulholland, 2014).

1.3 Statement of the problem

One can quickly locate hundreds of risk variables that influence the cash flows of a
typical pension fund. Fortunately, it is frequently possible to help reduce the number
of risk variables while maintaining the key characteristics of the distributions of asset
prices and responsibility payments. Finding the most pertinent risk variables that
have an impact on the measurements is the first stage in developing any stochastic

3
model. The market gains in various investments and the pension spending are the
interesting numbers in the process of managing pension funds. The longevity, price,
and salary inflation that are frequently employed in the indexation of defined benefit
obligations are the most significant sources of uncertainty on the liability side. There
are additional macroeconomic risk variables, such as the Gross Domestic Product,
that might indirectly influence the returns on investments or obligations.

1.4 Aims and Objectives

The research study is aimed at developing a Vector Autoregressive Model and Life
Tables model. This will be achieved through the following objectives:

• To determine the main effects, interaction and coefficient of the ages of partic-
ipants

• To develop a demographic model using Vector Autoregressive Model.

• To project death rate and life expectancy using the developed model.

• To develop life tables using the Lee Carter mortality model.

1.5 Significance of the study

This research study will assist the researcher in developing research skills towards
the fulfilment of the degree program in Actuarial Science. The research study will
also provide academic foundation on which similar studies can be founded for further
studies. This study serves the purpose of crafting various pension policies for various
individuals according to their age and contribution to the pension.

4
1.6 Project Layout
The literature evaluation, the explanation of words used in this related study, and
a review of studies that were conducted by other researchers are all provided in
Chapter 2. The approaches that will be utilized for data collection and analysis are
highlighted in Chapter 3. Research findings and data analysis will be covered in
Chapter 4. Chapter 5 is the final and concluding chapter, and it contains comments,
suggestions, findings, and research limitations.

1.7 Chapter Summary

The chapter presented background of the study and research problem statement on
survival of pension schemes during periods of hyperinflationary in Zimbabwe. The
chapter also alluded to the research aim and objectives. Significance of the study
was also discussed with the need to expound how it contributes to the researcher, the
university and community at large. The chapter also established the research project
outline which stated what each chapter will contain.

5
Chapter 2

Literature Review

2.1 Introduction
The chapter presents the literature review pertaining to survival of pension schemes
during periods of hyperinflationary in Zimbabwe. The literature will focus on credible
sources peer reviewed sources such as journals, books, articles and other published
papers. The literature review will establish the empirical and theoretical framework
of the study through articulation of some of the mathematical structures of different
models.

2.2 Conceptual Framework

2.2.1 Pension Actuarial Process

The process of assessing the assets and liabilities of a pension plan is known as pen-
sion actuarial science (Ezra 1980). Pension liabilities are estimates of the retirement
benefits that qualifying pension plan members and their beneficiaries might antici-
pate to receive from pension schemes. From the standpoint of a plan sponsor, the
actuarial process aids in :

• determining the present value of their future retirement payments

6
 • creating a savings plan to aid in distributing the budgetary costs of the pension
benefits over the time when their employees are employed and accruing pension
benefits.

There are many unknowns involved in the actuarial process (Ezra 1980). In attempt
to have all of the necessary holdings set aside to pay for the care by the time their
employees retire, sponsors respond to this uncertainty by making important presump-
tions about just the size of their future pension costs, the likelihood that upsides will
need to be compensated, and the portion of about there future payments that should
be currently funded. The future will become more definite and making assumptions
less important as employees get closer to retirement. In most cases, it is too late to
swiftly reverse a major shortfall in pension funds once benefit levels are known (or
even when they are very close to being known). The funds in the pension funds of
plan sponsors that make too optimistic assumptions will not be sufficient to pay the
benefits to their pensioners. Sponsors must boost their yearly contributions or use
assets from pension funds that were meant to be used for future retirement payouts
in order to make up the gaps. Actuaries use two sets of assumptions to determine
unfunded liabilities and contribution needs in order to prevent a funding gap (Amer-
ican Academy of Actuaries 2004). Human capital and the percentage of employees
who would ultimately be eligible for pension benefits are predicted using demographic
assumptions. Among the demographic presumptions are death, turnover, disability,
and termination rates. To estimate increases in the future earnings of pension bene-
fits and determine the present value of such future payments, economic assumptions
are applied. Discount rates, inflation rates, and wage growth rates are all examples
of economic assumptions. Actuaries utilize these hypotheses to determine the nec-
essary contributions and pension obligations. The current value of future welfare
payments that employees have already accrued is represented by pension obligations.

7
The total of the individual obligations for each eligible plan member is used to com-
pute the retirement liability for a company with many participants. Contribution
requirements are the annual contributions that must be made to a retirement fund
and jointly owned for prospective benefit payments as calculated by actuaries. Con-
tribution needs and liabilities are closely connected. The sum required to cover any
benefits obtained in the following year makes up a percentage of the contribution
obligations. The accumulation of regular expenses for all the put to good of employ-
ees’ employment is what is known as the rate of return accrued liability, or pension
liabilities. The pension plan acknowledges an unfunded actuarial accumulated liabil-
ity when a pension fund’s assets are insufficient to meet its AAL. Plans are mostly
not anticipated to cover the gaps in a single fiscal year. They are instead permitted
to finance the budget deficits over time (an amortization period). The second install-
ment of a sponsor’s contribution requirement is the amortized. The annual required
contribution, or ARC, is often defined as the sum of the regular cost and the amor-
tized UAAL. It is frequently represented as a percentage of the covered payroll of a
pension scheme. Although we continue to use the conventional ARC language in this
study, new accounting rules refer to this computation as the actuarially determined
contributions. The actuarial method makes the premise that circumstances will shift
and that new presumptions will need to be made. As a result, actuaries periodically
examine the terms of the plan, often no less frequently than just about every other
five years, and determine whether the actuarial assumptions are supported by real
experience.Actuaries frequently recommend modifying actuarial inputs depending on:

• evolving professional standards (such as new mortality data).

• evolving governmental accounting rules.

• if real circumstances differ from actuarial assumptions.

Actuaries may recommend improvements, but boards of trustees and the governing

8
bodies of sponsoring governments are in charge of reviewing these ideas and decid-
ing whether to make changes to the actuarial inputs. Academic research suggests
that in order to increase spending on current government services, decision-makers
may exploit the latitude provided by accounting rules to embrace actuarial assump-
tions that defer pension expenses (Johnson 1997; Marks, Raman and Wilson 1988).
Governments experiencing fiscal difficulty are regarded to have a particularly strong
motivation to embrace advantageous actuarial inputs (Chaney, Copley, and Stone
2002; Giertz and Papke 2007; Mitchell and Hsin 1997; Schneider and Damanpour
2002). Others claim that political pressure influences the choice of actuarial inputs
(Romano 1993). For instance, Levine, Rubin, and Wolohojian (1981) discovered that
the City of Oakland’s pension system raised its amortization term from 14 years to
40 years during the 1970s financial crisis. Additionally, Eaton and Nofsinger (2004)
discovered that governments subject to political pressure and financial restrictions
reduced their estimates for pay growth rates, extended their amortization durations,
and raised their discount rates. States with balanced budget requirements raised their
discount rates while under financial strain, according to research by Chaney, Copley,
and Stone (2002). Furthermore, anecdotal evidence backs up assertions that actuarial
assumptions are occasionally changed to enhance short-term political and budgetary
situations. Early in the 1990s, the State of New York modified how the costs of its
pension liabilities were distributed in response to a financial crisis (Bentley 2009).
The state of New York was sued over that choice, and the court decided against the
state, finding that the modification was made to address the financial problems facing
the state’s governmental organizations rather than to ”guard the retirement assets
earned by members and beneficiaries of the system” (McDermott v. Regan 1993,
359). The City of Philadelphia revealed a proposal in 2009 to increase its amortiza-
tion term from 20 to 40 years and cut its ARC by one hundred and seventy million
dollars (Lucey 2009). And in 2013, a member of the Columbia Board of Investments

9
stated that the Board had changed its mind about lowering the discount rate for the
Columbia Public Employees Retirement Systems because of intense governor pressure
(Johnson 2013).

2.2.2 Pension Schemes

A pension fund is defined by Wyatt (2003) as a structure established by a business,

a governmental agency, or a labor organization to provide future pension payouts for
workers who have retired. They are set up as a capital investment framework that of-
fers income throughout retirement for the aim of retirement planning. It is frequently
produced for workers by businesses or the government (Brown, 2007). According to
Arunajatesan and Viswanathan (2009), the delayed salary idea serves as the founda-
tion of a pension plan. A pension is seen as a portion of a paycheck that has been set
up for retirement and postponed. Instead of paying the employee’s salary or wages
right away, the employer builds up a fund and pays them as a retirement benefit.
According to Dorfman (2004), the retirement benefit is comparable to a pure annu-
ity since it is paid out in regular monthly installments throughout the course of the
recipient’s lifetime. Workers who are fully covered at the time of their typical work-
ing age are eligible for a full retirement payout. A pension plan’s purpose is to give
participants retirement income. Retirement is the permanent termination of an em-
ployee’s active employment due to advancing age or illness. According to the OECD
( Organization for Economic Co-operation and Development) (2005), pension plans
or retirement schemes are made to play a significant part in monetarily motivating
people, eventually boosting performance results that assist the fulfillment of corpo-
rate goals. In speaking, a pension is a plan that gives people financial security when
they stop receiving a monthly paycheck from their job. It is a method of tax-deferred
savings that enables the accumulation of money for use as retirement income in the
future. Pension funds are corporate-sponsored funds designed to give firm employees

10
enough money to live on after retirement. The pay as you go system, such as benefits
provided by the National Social Security Authority, varies from this system in that
the payments paid are invested on securities for extremely long periods of time. As a
result, the provision made will rely on the performance of the investment portfolio in
addition to the level of contributions (Wyatt, 2003). Employers, insurance firms, the
government, or other organizations like employee groups or trade unions may create
retirement programs (Vaughan, 2000). Pension schemes and superannuation plans are
other names for retirement programs. Emmet (2000) also noted that while pensions
frequently provide compensation to survivors or beneficiaries who are handicapped,
many of them also have supplementary insurance components.

2.2.3 Longevity Risks and Pensions

According to Jones (2013), longevity risk has an impact on:

• governments who need to fund guaranteed retired individuals through pensions

and healthcare from a shrinking tax base.

• corporate sponsors that must pay for retirement and medical coverage commit-
ments made to former employees over a long period of time.

• individuals who may have a reduced or nonexistent ability to rely on govern-

ments or corporate sponsors to finance retirement.

The impact of the longevity risk on the rewards of living must be carefully considered.
Reinsurance plans and capital planning can provide the necessary instruments to ad-
dress this risk (Edwards & Munhenga, 2011). However, it is important to take into
account the problem of ”finding” the longevity risk through potential pooling, for ex-
ample, between the annuity provider and the annuitant. The main areas of study on
the demographics of aging are summarized by Schoeni & Ofstedal (2010). Population

11
trends (including mortality), international comparisons, the financial implications of
aging, and characteristics of wellbeing in later life are among them. The world’s pop-
ulation is aging as a result of the global fall in fertility and death rates from higher
to lower levels. Worldwide, there is an aging of the population. The fastest popu-
lation aging is occurring in developing countries, whilst developed ones have already
experienced it. They also discuss how the elder generation is aging. Over 80s make
up a larger percentage of the older generation than the older generation as a whole.
Additionally, there are 11 separate nations and geographical areas in the planet. In
the past 50 years, longevity has increased, mostly due to the elimination of infectious
diseases and the successful treatment and management of chronic illnesses (Edwards
& Munhenga, 2011). However, as the proportion of older people increases worldwide,
governments confront challenging challenges in the areas of health care, retirement
plans, and labor market supply. Older people use more medical services and drugs,
and because of their longer lifespans, they may be receiving retirement and other se-
niority benefits for longer periods of time than was previously thought.Additionally,
national security and pension plans that depend on current employees’ taxes to fund
retiree benefits (a ”pay-as-you-go” model) become progressively unsustainable as the
proportion of older people compared to those in their working years rises (Kathyuka,
et al, 2014). When there are recent trends in death, predicted survival models are
used in determining the cost and setting aside funds for life annuities and other long-
term benefits (Rizzuto & Orsini, 2012). Actuarial practice makes use of a number
of projection models that have been put out. Nevertheless, because the trend in
mortality is unpredictable, systematic departures from the predicted mortality are
possible regardless of the model that is used. A theory of risk—clearly a non-pooling
risk—emerges at that time. The mortality trend can change for both young and old
people. Typically referred to as ”longevity risk,” the random mortality trend in old
age (Rizzuto & Orsini, 2012).

12
2.3 Valuation of Longevity Risk
For every pension business, analyzing longevity and its consequences and predicting
future death rates are essential (Taruvinga & Gatawa, 2010). The longevity of a
person has always been of interest to people. Demography and actuarial science have
a long history of predicting mortality trends. Mortality predictions were used by de-
mographers to estimate future populations, while actuaries used them to anticipate
cash flows and evaluate premiums and reserves in pension annuities and life insurance
companies. The mortality predictions were utilized by several groups to inform their
policy choices (Trauth & Reimer- Hommel, 2000). An actuary must conduct an eval-
uation of a plan’s actuarial value at least every three years. By calculating the value
of obligations and comparing it to the value of assets, this analysis tries to evaluate
the financial situation of the pension system by estimating the cost of paying out
pensions for all of its members. We must make several assumptions in order to do a
valuation, such as the financial assumptions of the discount rate, pension rise rates,
inflation rates, and salary increases. Demographic assumptions include mortality, the
proportion of married people and the age gap between them, early retirement due
to illness, the typical retirement age, withdrawal from the plan, and commutation.
Actuaries regard actives as delayed members when determining a solvency estimate
because they presume the closure of the plan at the valuation date. With this as-
sessment, we may determine how much money is required to purchase all the benefits
accrued from an insurance business since solvency assesses the cost of a buy-out. In
order to avoid insolvency, plans frequently employ a de-risking method while under-
taking a buy-out. While arriving at these figures does not include implementing a
buy-out, it does inform us of what will be required if schemes choose to take that
course. Although it is the most expensive strategy, members and trustees believe it
to be the safest way to limit the scheme’s liability exposure.

13
2.3.1 Solvency/Insurance Buy-out

To calculate a solvency estimate, actuaries assume the closure of the scheme at valu-
ation date and treat actives as deferred members. Since solvency measures the price
of a buy-out, with this valuation we can know how much money is needed to buy all
the benefits accrued from an insurance company. Usually, schemes apply a de-risking
strategy while performing a buy-out, to prevent insolvency. Calculating these esti-
mates does not mean applying a buy-out however it let us know what will be needed
if schemes want to follow that path. This is the most expensive approach, but for
the members and trustees it is considered the safest method to protect the scheme’s
liabilities.

2.3.2 Self-Sufficiency

A plan acquires self-sufficiency when its assets are sufficient to satisfy its commitments
and no further contributions are expected. From this point forward, the asset holding
strategy should be low-risk to reduce the likelihood of becoming dependent on the
employer.

2.3.3 Accounting Valuation

Employers utilize the accounting valuation to publish their annual Reports and Ac-
counts, giving stakeholders the knowledge that pension plans are taken into account
when calculating liabilities and providing a consistent dimension of accounting ex-
penses across similar organizations. The appropriate accounting rules of the com-
pany’s native country describe the assumptions that were applied. The objective of
developing new approaches during the past 20 years has been to predict mortality us-
ing stochastic models. Since stochastic models incorporate a confidence error into each
estimate, they seem more enticing than the earlier deterministic models. According
to Lee and Carter (1992), the LC model was applied to anticipate death rates in the

14
United States. Since it yielded accurate fits and projections of death rates for many
countries, this model has been widely utilized for both demographic and actuarial
purposes. For instance, the Lee Carter model was applied in the Nordic nations, Bel-
gium, Austria, Australia, and Japan. Second, the structure of the Lee-Carter model
enables the creation of confidence intervals for mortality forecasts. Despite having a
respectable performance, the LC model had a few limitations (Lee 2000), which led to
unfavorable effects. As a result, new stochastic models were created, with Renshaw
and Haberman (2006) and Cairns et al. models being the most notable models (2006,
2007, and 2008). The number of sources of randomization driving mortality improve-
ments at various ages, the assumptions of regularity in the age and period dimensions,
the inclusion or exclusion of cohort effects, and the estimate technique all play a sig-
nificant role in how stochastic models differ from one another. The RH model, which
integrates cohort effects in the population, will be used to model longevity risk as
the focus of the study. The term ”cohort effect” refers to the fluctuation in health
status caused by many factors that each age cohort in a population is exposed to as
the environment and society change (Gustafsson, 2011). A cohort study is a study
of a group of people who have something in common, such as a similar experience,
over a certain period of time (Rizzuto Orsini, 2012). The most famous example is a
”birth cohort,” which refers to a group of people who were born at the same time or
in a comparable timeframe (Gustafsson, 2011). In a prospective study, the focus of
this investigation, we track a group of people across time by looking for patterns in
effects or results brought on by cohort changes within the group. However, material
is gathered for a review examination based on specific findings from previous records.
A cohort study, whether prospective or retrospective, is the final step in establishing
a connection between a disease and exposure.

15
2.4 Role of Pension Funds
According to the OECD (2005), a pension fund is a legally distinct collection of as-
sets that constitutes a separate legal entity and is purchased with contributions to a
company pension for the purpose of paying a pension plan benefit. Everyone wants
security, to not be dependent on their family for assistance after retirement, and to
not be a burden for the rest of their life. Consequently, pension plans enable one
to make investments now to ensure financial stability in retirement someday (Gore,
2006). Therefore, through pension funds, retirement planning improves personal se-
curity now and in the future. When someone goes through one of life’s significant
events, social security might be seen as a tool to provide them more independence
in their personal lives (Brown, 2007). When Kingson and Berkowitz (1993) stated
that social security ”arguably helps underwrite dignity, strengthen family life, and
stabilise economies,” they were in agreement with Brown. They noted that social
security ”brings incentives as an earned right while protecting sensitive women and
families against job anxiety.” When Ward and Zurbrueg (2000) observed that as we
age, we work, create, and earn less, and as a result, require a stable source of in-
come to go through life, they were in agreement with this school of thinking. Pension
funds, according to a 2021 Internal Revenue Service study, act as financial mediators
between investors and economic agents who lack enough finance, advancing the inter-
ests of developing nations by alleviating the burden of providing for retirees’ financial
security requirements. Not only that, but pension funds may also collect substantial
sums of cash from sizable pools of policyholders, which are then utilized for invest-
ments, boosting economic growth and helping the national economy. According to
Harrington et al. (2003), planning for retirement, which may be the most stressful
stage of all, has historically received little attention. He said that because retirement
sometimes feels like being abandoned on the trash heap and let to fade away and pass

16
away as swiftly and silently as possible, many people who are unprepared for change
view it as being dumped upon the scrap heap. In exchange for making payments over
time, employees may use the pension system as a financial service vehicle to safeguard
both themselves and their elderly relatives when they retire, claims Schultz (2012).
When Schulz stated that the problem was how to accommodate an aging population,
maintain and enhance the wellness of the elderly, and boost their contribution to eco-
nomic and social progress, Ganguly (2012) concurred. It is necessary to abandon the
notion that reliance comes with becoming older and to accept the difficulties of active
aging. Pension plans are made to serve as a significant financial incentive for employ-
ees, consequently enhancing performance results that aid in the accomplishment of
organizational objectives. Therefore, standardized financial incentive programs were
created based on work measurement on the presumption that, since people are mo-
tivated primarily by rewards, particularly money, they would maximize their work
output if the incentive of additional money for each promotion at work was provided
(Gore, 2006).

2.5 Types of Pension Funds

2.5.1 Defined Benefit Schemes

In a defined benefit plan, according to Will (2021), employees accrue a guarantee of a

consistent monthly payment from the time they retire until their deaths, or in certain
situations, until the deaths of their spouses. As reimbursements are based on tenure
and income, participants in these insurance programs have low market risk. However,
the back-loaded nature of benefit accrued in DB plans means that pensioners collect
very little in terms of retirement wealth prior to retirement. Due to this, employees
who quit their positions at the beginning or in the midst of their employment careers
get limited benefits, and those who do so before to vesting (often at five years) receive

17
nothing. Therefore, for employees with DB plans, job transitions pose a significant
danger to retirement savings. The member receives a unit of compensation for each
year of acknowledged service, which is often stated as a proportion of nominal wages.
Defined benefit plans may be fully or partially financed (2021). An unfunded DB
pension has no assets set away, and the employer covers the cost of the benefits. It
was also said that most governments throughout the world offer unfunded pension
plans, with taxes and employee contributions serving as the sole source of funding
for benefits. The name of this funding strategy is Pay as you Go. A funded plan
invests employee and occasionally plan participant payments into a fund to help it
accomplish its objectives. To guarantee that the pension fund will be able to fulfill
future commitments, the contributions will be constantly evaluated in a valuation of
the plan’s assets and liabilities. This means that under a defined benefit plan, the
employer, not the participant, often assumes investment risk and reward.

2.5.2 Defined Contribution Schemes

Participants in this plan are solely responsible for saving for their own retirement,
according to Yermo (2018). The employee can use a variety of mutual funds, also
known as unit trusts, that the company often offers as a vehicle for retirement savings.
In this program, before taxes are deducted from salaries, employees are permitted to
invest in mutual funds of their choosing. The employer also makes a partial contri-
bution to the fund. Employee contributions are taken directly out of their paychecks
and represent a certain proportion of wages. Over time, DC assets grow at a com-
paratively stable rate, preventing back loading of accumulated benefits. Since the
funds in this plan are handled by the employee, he or she has the option of leaving
the assets of the plan in the care of a former employer, moving the assets to a new
employer, or moving the assets to an IRA. Even though benefits must be vested, only
employee contributions plus interest are repaid if the plan is canceled before the date

18
of the vesting event (Sonnastine, Murphy & Zorn, 2017). The contributions are set
in relation to a defined proportion of pay. Such contributions’ cumulative value is
used to purchase pension (Arunajatesan and Viswanathan, 2019). The employee’s
eligibility for a benefit is not predetermined. It is gaining popularity and depends
on how well the plan’s funds perform. The program offers a variety of pensions,
including pensions payable for life, joint life last surviving pensions, and pensions
payable for life with refund of purchase price upon pensioner death. The money buy
plan is the most straightforward kind of defined contribution plan (Dorfman, 2019).
The cost of a money purchase program is known, but not the advantages that will
be received. Each member’s unique account is where the stipulated employee and
employer contributions are accumulated (Axelrod, 2020).

2.5.3 Hybrid Schemes

Hybrid plans are those that are neither fully DB nor fully DC schemes but contain
certain elements of both, according to The Pensions Authority (n.d.). In hybrid
systems, risks might be split between the company and the employee. A hybrid plan
is sometimes referred to as a plan that incorporates aspects of the DC pension system
(Sedgwick, 2000). According to Sonnastine, Murphy, and Zorn (2007), several plans
have implemented benefit designs that integrate both the final salary and money
purchase principles in order to satisfy the pension goals of various sorts of employees.
A member may get a controlling for potential on a systematic investment formula
if it results in a greater pension as a ”underpin” to a final salary benefit. German
pension systems, which are predominately hybrid, would serve as an example of a
nation that does this. Legally speaking, only DB plans in the form of final salary
plans are allowed; pure DC plans are not. A ”contribution focused” DB plan is the
most common form of plan. The employer guarantees a pension payout based on
pre-determined contributions, therefore it is essentially a compensation plan.

19
2.6 Empirical Models
2.6.1 Basis of Financial Developments

It is anticipated that social security programs, which are supported by national gov-
ernments, would continue eternally. In other words, it is assumed that there will
always be a steady stream of new enrollees. Since the starting population and fu-
ture entrants are treated as a single group for this purpose, the financial systems
for social security pension plans are based on the so-called open fund concept. Any
financial system’s primary goal is to achieve an equilibrium between the scheme’s
revenue and expenses; however, doing so does not necessarily equate contributions
to current spending, which is simply one method of doing so. The fact that there
are, in principle, an infinite number of financial systems that may be applied to the
scheme is really a significant consequence of the maturation process of a pension
scheme. The contribution rate function Ct, which describes the financial system, and
the reserve function Vt, which reflects the difference between intake and outflow that
has accumulated with interest at force six, are now presented for the consideration of
financial systems. These functions are connected to the functions B(t) and S(t) by
the fundamental differential equation (Zelenka, 2019):

dV (t) = V (t)δdt + C(t)S(t)dt − B(t)dt (2.6.1)

In other words, every modest change in the reserve is equivalent to the difference be-
tween the revenue from investments on the reserve during that interval and the income
from contributions over the costs of benefits during that same interval. The following
relationship between the values of the reserve function is generated by integrating the
aforementioned equation over the interval ai t = n and t = m:
Z m
−δm −δn
V (m)e = V (n)e + [C(t)S(t) − B(t)]e−δt dt (2.6.2)
n

20
The expression for V(m) is then obtained as
Z m
δ(m−n)
V (m) = V (n)e + [C(t)S(t) − B(t)]eδ(m−t) dt (2.6.3)
n

In particular, putting n = 0 and taking V(0) = 0, the following retrospective expres-

sion for V(m) is obtained:
Z m
V (m) = e δ(m)
[C(t)S(t) − B(t)]e−δ(t) dt (2.6.4)
0

For the period of a pension plan, an equilibrium equation may be formulated. By first
equating the present value of the future contribution stream to the present value of the
future expenditures, it is possible to state the equivalence of receipts and payments
while accounting for the time value of money:
Z ∞ Z ∞
−δ(t)
C(t)S(t)e = B(t)e−δ(t) dt (2.6.5)
0
Z m Z0 ∞
[C(t)S(t) − B(t)]e−δ(t) = [B(t) − C(t)S(t)]e−δ(t) dt (2.6.6)
0 m
Z ∞
−δ(m)
V (m) = e [B(t) − C(t)S(t)]e−δ(t) dt (2.6.7)
m

2.6.2 Pay as you go Financial System

Theoretically, the pay-as-you-go (PAYG) financial system can be defined by the con-
dition V(t) = 0 for all values of t.
B(t)
C(t) = (2.6.8)
S(t)
Theoretically, the pay-as-you-go (PAYG) financial system can be defined by the con-
dition V(t) = 0 for all values of t.
R n+1
B(t)e−δ(t) dt
P AY Gn+1 = Rnn+1 (2.6.9)
n
S(t)e−δ(t) dt
If contribution inflow and benefit outflow are assumed to be uniformly distributed
over the year, the contribution rate can be expressed as:
R n+1
B(t)dt
P AY Gn+1 = Rnn+1 (2.6.10)
n
S(t)dt

21
However, inflow of cash within the year may not exactly match outgo. More- over,
allowance will need to be made for unexpected variations from the projected values of
the contribution income or the benefit expenditure over the year. It is therefore the
practice to add a small margin to the calculated contribution rate in order to build
up a contingency reserve to sustain cash now.

2.6.3 General Average Premium System

The general average premium (GAP) system is based on the concept of a constant
contribution rate applicable throughout the subsequent lifetime of the pension scheme.
Taking the view at t = m and putting C(t) = C (a constant), the following expression
is obtained for the general average premium for the interval (m, ∞):
R∞
B(t)e−δt − V (m)e−δm
C = m R∞ (2.6.11)
m
S(t)e−δt dt

More particularly, if the view is taken at the outset of the scheme, the general average
premium - indicated by GAP - will be given by
R∞
B(t)e−δt dt
GAP = R0∞ (2.6.12)
0
S(t)e−δt dt

An average premium API for the initial population and an average premium AP2 for
new entrants can be determined as follows:
R∞
0
B1(t)e−δt dt
AP 1 = R ∞ (2.6.13)
0
S1(t)e−δt dt
R∞
B2(t)e−δt dt
AP 2 = R0∞ (2.6.14)
0
S2(t)e−δt dt

The GAP can then be expressed as follows:

R∞ R∞
AP 1 0 S1(t)e−δt dt + AP 2 0 S2(t)e−δt dt
GAP = R∞ (2.6.15)
0
S(t)e−δt dt

This shows that the GAP can be regarded as a weighted average of API and AP2.

22
2.6.4 Terminal Funding System

Among the several intermediate financial systems, between the PAYG and GAP sys-
tems, the terminal funding system deserves special mention. This financial system
is usually applied to pension benefits provided under employment injury insurance
schemes. It has occasionally been applied to social security pensions. This system
has sometimes been referred to as the ”assessment of constituent capitals” system,
in other words, full pre-funding at the time of award. Let Ka(t) dt represent the
capitalized value of the pensions awarded in the interval (t,t + di). Then the present
value of future benefit expenditures can also be expressed in terms of the function
Ka(i), as follows: Z ∞ Z ∞
−δt
B(t)e dt = Ka(t)e−δt dt (2.6.16)
0 0

The fundamental equation of equilibrium can therefore be expressed as

Z ∞ Z ∞
−δt
C(t)S(t)e dt = Ka(t)e−δt dt (2.6.17)
0 0

An obvious solution to the above equation, denoted by TFS(t), is

Ka(t)
T F S(t) = (2.6.18)
S(t)

The reserve V(n), representing the capitalized value of current pensions, is given by
Z n
V (n) = e δm
[Ka(t) − B(t)]e−δt dt (2.6.19)
0

In practice, the terminal funding system will not operate on a continuous basis, but
will be applied over finite time intervals (for example, annual periods).

2.6.5 Successive Control Periodic System

By dividing the lifespan of a pension scheme into successive intervals of finite length
and choosing a level contribution rate for each time window such that the reserve

23
function V(t) satisfies a specific condition over the interval, a whole series of interme-
diate financial systems, between PAYG and GAP systems, can be created. The time
leading up to financial maturity, for instance,the interval (0,0)2 may be split into h
intervals, which need not be equal. Let any one of these intervals be represented by
(n, m). In addition, the reserve function expression at any intermediate time point
will be: Z n
δ(u−n)
V (u) = V (n)e + [C(t)S(t) − B(t)]eδ(u−t) dt (2.6.20)
u

The level contribution rate (denoted by C) for the interval will then be given by
Rm
n
B(t)e−δt dt
C= m R (2.6.21)
n
S(t)e−δt dt
Another variant specifies the ”reserve ratio” at t = m. This ratio is defined as
V (t)
k= (2.6.22)
B(t)
The following expression is obtained for the level contribution rate:
Rm
k0 B(m)e−δm + n B(t)e−δt dt − V (n)e−δn
C= Rm (2.6.23)
n
S(t)e−δt dt
More stringently, a minimum reserve ratio K0 might be required throughout the
interval (n, m). A further variant specifies the ”balance ratio” at t = m. This ratio
is defined as
B(t) − CS(t)
λ= (2.6.24)
δV (t)
This ratio indicates the extent to which the interest on the reserve, or the reserve
itself, is used, on top of current contributions, for balancing current expenditure.
Rm
B(m)e−δm + δλ0 n B(t)e−δt dt − δλ0 V (n)e−δn
C= Rm (2.6.25)
S(m)e−δm + δλ0 n S(t)e−δt dt
A general formula connecting the level contribution rate, with the expenditure, salary
and reserve functions can be derived as follows:
Z ∞ Z ∞
−δz
V (ω2 ) + Π S(ω2 + z)e dz = B(ω2 + z)e−δ dz (2.6.26)
0 0

24
Hence the final equation becomes:

V (ω2)(δ − ρ − γ) = B(ω2) − ΠS(ω2) (2.6.27)

2.6.6 Scaled Premium System

One specific example of systems based on subsequent control periods is the scaled
premium system. But in this part, this system is handled separately. This system
was originally conceptualized (Zelenka, 2018) as follows: a level contribution rate is
determined, but is successfully implemented over a shorter time period during which
the reserve grows constantly and reaches a local maximum. This level contribution
rate would balance income and expenditure over a limited preliminary period of years
called the very first period of equilibrium. If the reserve reaches a regional maximum
at t = m, V’(m) = 0. Substituting in the fundamental differential equation, the
following expression for the terminal reserve is obtained:
B(m) − Π(n, m)S(m)
V (m) = (2.6.28)
δ
Substituting for V(m) in the general expression for the reserve and simplifying, the
following expression is obtained for the level premium for the interval (n,m):
Rt
B(t)e−δt + δ n B(z)e−δz dz − δV (n)e−δn
π(t) = Rt (2.6.29)
S(t)e−δt + δ n S(z)e−δz dz
Rm
B(m)e−δm + δ n B(z)e−δz dz − δV (n)e−δn
π(n, m) = Rm (2.6.30)
S(m)e−δm + δ n S(z)e−δz dz
The proof can be derived through letting the reserve under the application of pi(t) in
(n,t) be denoted by R(u, t), n < u < t, given by
Z n Z u
−δu −δn −δz
R(u, t)e = V (n)e + π(t) S(z)e dz − B(z)e−δz dz (2.6.31)
u n

Putting u = t in the fundamental differential equation for the interval (n, t) expressed
as a partial differential equation in the present context that is,
∂R(u, t)
= ∂R(u, t) + Π(t)S(u) − B(u) (2.6.32)
∂u

25
Differentiating and implying

π`(t)D(t)2 eδt = D(t)B`(t) − N (t)S`(t) (2.6.33)

It can be shown that the PAYG premium

B(t) N (t)
> . (2.6.34)
S(t) D(t)
Multiplying both sides by S(t)D(t) which, being positive, does not change the sign

B(t)D(t) > S(t)N (t). (2.6.35)

It will be noted that both sides of the above inequality are positive. Therefore,
1 1
> . (2.6.36)
N (t)S(t) B(t)D(t)
Also, multiplying both sides S(t)B(t), which being positive, does not change the sign

B`(t) ≥ S(t)S`(t)B(t). (2.6.37)

Multiplying both sides by N(t)D(t) which, being positive, will not change the sign
B`(t) S`(t)
> . (2.6.38)
N (t) D(t)

2.7 Lognormal distribution

Let y denote the salary and let z = loge y, where0 < y < ∞and − ∞ < X < ∞.It is
assumed that y has the lognormal distribution, or in other words, z has the normal
distribution. Let the parameters of the distribution of z be denoted by the mean and
variance. The probability density function of z is:
1 (z − u)2
p(z) = √ exp(− ) (2.7.39)
σ 2π 2σ 2
The parameters of the distribution of y can be expressed in terms of integrals of the
distribution of z, simplified and then expressed in terms of the distribution function

26
of the standard normal varı́ate. Let z(a) and z(b) denote the corresponding values of
z. let F(y) and G(y) denote the distribution function of y and z. Then,

F (yb ) − F (ya ) = G(zb ) − G(za ). (2.7.40)

The required average, denoted by A, is given by

R yb
ya
yp(y)dy
A= . (2.7.41)
F (yb ) − F (ya )
Changing the variable to z in the numerator,
R zb z
e p(z)dz
A = za . (2.7.42)
G(zb ) − G(za )
The integrand of the numerator which, has the expression:
1 (z − u)2
√ exp(− + z). (2.7.43)
σ 2π 2σ 2
can be simplified as
1 σ2 (z − µ − σ 2 )2
√ exp(µ + )exp(− + z) (2.7.44)
σ 2π 2 2σ 2
By changing to the standardized variable t,
z−u
t= −σ (2.7.45)
σ
and noting that the overall mean of the distribution of y, say B, is
σ2
(µ+ )
B=e 2 (2.7.46)

It follows that A can be expressed, in terms of 5 and the distribution function of the
standard normal varı́ate, as:
ϕ(wb − σ) − ϕ(wa − σ)
A=B , (2.7.47)
ϕ(wb ) − ϕ(wa )
where
za − µ zb − µ
wa = andwb = (2.7.48)
σ σ

27
2.8 Financial Annuities
Assume that a unit amount is paid at the beginning of each year for n years. This
series of payments is referred to as an annuity-due. The present value of the annuity-
due is the sum of the present values of the individual payments. It has the following
symbol and expression:

2 n−1 1 − vn
a¨n⌝ = 1 + v + v + ...... + v = (2.8.49)
1−v

If the annual payments are made at the end of each year, the annuity is called an
immediate annuity. It has the following symbol and is related to the annuity-due as
indicated:
an⌝ = va¨n⌝ (2.8.50)

The accumulated value of an annuity is the sum of the accumulated values of the
individual payments. For example, the accumulated value of an immediate annuity
has the following symbol and expression:

sn⌝ = (1 + i)n−1 + (1 + i)n−2 + ... + (1 + i) + 1 = (1 + i)n an⌝ (2.8.51)

More generally, an annuity may be payable in m instalments spread evenly over the
year. Depending upon whether the payment is made at the end or the beginning of
each fractional period, this annuity is symbolized and evaluated as follows:

(m) i
an⌝ = an⌝ (2.8.52)
i(m)
(m) i
(m)
a¨n⌝ = an⌝ + an⌝ (2.8.53)
m
1
i(m) = m[(1 + i) m − 1] (2.8.54)

For theoretical purposes, it is possible to conceive of a continuous annuity, where

a unit amount per year is assumed to be invested continuously over the year. The

28
corresponding present and accumulated values have the following symbols and ex-
pressions:
1 − e−δn eδn − 1
a¯n⌝ = ; s¯n⌝ = (2.8.55)
δ δ

2.9 Life Annuities and Assurances

A series of payments of one unit at the beginning of each year, payable so long as a
life aged x is alive, is called a life annuity-due. The probable present value of this
annuity has the following symbol, and it can be expressed in terms of the elementary
commutation functions as indicated:

Nx
a¨x = (2.9.56)
Dx

If the payments are made at the end of each year, the annuity is termed an immediate
life annuity. It is denoted by the symbol ax and has the following expression:

Nx+1
ax = (2.9.57)
Dx

A life annuity, due or immediate, may be payable in m equal instalments spread evenly
over the year. It has then the following symbols and the approximate expressions,

m−1
a¨(m)
x = a¨x − (2.9.58)
2m
m−1
a(m)
x = ax − (2.9.59)
2m

A continuous life annuity is one where a unit per year is paid continuously over
the year. Its probable present value is denoted as follows and has the approximate
expression
N¯x
a¯x = (2.9.60)
Dx
where,
Nx + Nx+1
N¯x = (2.9.61)
2

29
If the term of a life annuity is limited to n years, it is termed a temporary life annuity.
For example, a temporary life annuity-due is denoted by the following symbol and
has the expression,
Nx − Nx+n
a¨x:n⌝ = (2.9.62)
Dx
Similarly

Nx+1 + Nx+n+1
a¨x:n⌝ = (2.9.63)
Dx
N¯x − N¯x+n
a¨x:n⌝ = (2.9.64)
Dx

Further,

(m) m−1 Dx+n

ax:n⌝ = ax:n⌝ + [1 − ] (2.9.65)
2m Dx
(m) m−1 Dx+n
a¨x:n⌝ = a¨x:n⌝ + [1 − ] (2.9.66)
2m Dx

A joint life annuity is one which is payable as long as two lives aged x and y are
both alive. If it is payable at the end of each year, it has the following symbol and
expression:
lx+t ly+t t
axy = Σt v (2.9.67)
lx ly
where t runs from 1 to the end of the period of payment. An annuity payable to a
life aged y after the death of a life aged x is called a last survivor annuity and has
the symbol and expression
a x = ay − axy (2.9.68)
y
If a unit amount is payable at the end of the year in which a life aged x dies, the
arrangement is called a whole life insurance. The probable present value of the insur-
ance is denoted by Ax and is given by;

Mx
Ax = (2.9.69)
Dx

30
An endowment insurance is given by the expression
Mx − Mx+n Dx+n
Ax:n⌝ = + (2.9.70)
Dx Dx
In this case, the assured amount is paid at the end of the year of death, if death occurs
within a term of years, or on survival to the end of the term. An endowment insurance
is seen to be the sum of a temporary (or term) insurance and a pure endowment. If
the sum assured is payable immediately on death, Mx in the above expressions should
be replaced by;
Mx + Mx+1
M¯= (2.9.71)
2

2.10 Renshaw and Haberman Model

Renshaw and Haberman (2006) generalized the Lee–Carter Method to capture the
effects of cohorts. This modification to the Lee-Carter model was done by simply
3
including a cohort factor γt−x to capture effects that could be attributed to the year
of birth t-x. This model postulates that mx,t satisfies:

(2) (3)
logmx,t = βx(1) + βx(2) kt + βx(3) γt−x (2.10.72)

(2) (3)
Where period effect kt follows and γc is a cohort effect where c = t − x is the year
(3)
of birth.They postulated that cohort effect γc is modeled as an ARIMA (1, 1, 0)
(2)
process that is independent of kt that is:

(3) (γ)
∆γc(3) = µγ + α(∆γc−1 − µy ) + αγ ZC (2.10.73)

2.11 Currie Age-Period-Cohort Model

Currie (2006), simplified the Renshaw and Haberman model, where the age, period
and cohort effects influence mortality rates independently. It was modelled as follows:

(2) (3)
logmx,t = βx(1) + kt + γt−x (2.11.74)

31
2.12 P-Splines
According to Currie et al (2004), basis splines are a set of basic functions constructed
from cubic splines. To estimate the parameters they maximized the following regres-
sion equation:
αy
logmx,j = Σi,j Θi,j βi,j (x, t) (2.12.75)

2.13 Cairns-Blake-Dowd 1 Model

This is the original CBD model developed by Cairns, et al. (2006). The model
postulates that mortality rates qx,t satisfy:

(2)
logitx,t = kt1 + (x − x¯)kt (2.13.76)

Where,
1
βx(1) = 1, βx(2) = (x − x¯) and x¯= Σ i xi (2.13.77)
nα
is the mean age over the ranges of ages used in the analysis.

2.14 Funding of Occupational Pension

2.14.1 Individual Cost Method

Individual cost approaches evaluate the changes needed to reach the closed-fund equi-
librium of the initial population after first addressing the financial equilibrium of new
entrants. When it comes to retirement pensions, for instance, the contributions made
throughout a new generation’s active existence should have accrued to the capital
value of the pensions of individuals reaching that age by the time they reach retire-
ment. Let K(x) represent the age-related contribution rate function and F(x) the
reserve function per unit salary bill at entry
Z r a
lz SSz γ(z−b) −δ(z−b) r − b lar Sr γ(r−b) −δ(r−b)
K(z)e e dz = e e a¯r (2.14.78)
b
b la Sb 100 lba Sb

32
The above equation can be simplified and expressed in terms of commutation func-
tions as follows:
r
r − b as(δ−γ) −p(δ−β)
Z
Das(δ−γ) K(z)dz = D a¯r (2.14.79)
b 100 r
Assuming that the experience coincides with the initial assumptions, the reserve func-
tion at age x per unit salary bill at entry can be derived by accumulating the contri-
butions paid from age b to age x, as follows:
Z x a
lz Sz
F (x) = b S
K(z)eγ(z−b) eδ(x−z) dz (2.14.80)
b la b

and then simplified and expressed in terms of commutation functions as follows:

Z x as(δ−γ)
δ(x−b) Dz
F (x) = e as(δ−γ)
K(z)dz (2.14.81)
b Db

Multiplying both sides by e−δ(x−b) and then differentiating both sides with respect to
x,
as(δ−γ)
Dx
[F´− δF (x)]e−δ(x−b) = as(δ−γ)
K(x) (2.14.82)
Db
This gives the following expression for K(x):
as(δ−γ)
Dx
K(x) = as(δ−γ)
= [F´− δF (x)]e−δ(x−b) (2.14.83)
Db

2.14.2 Accrued Benefits Costs

The part of the final pension benefit obtained at each time interval is funded using
accrued benefit cost techniques. This will automatically result in the reserve fund
F(x) being equal to the likely present value of the portion of the eventual benefit
accumulated up to that age, assuming that the experience is consistent with the
starting assumptions. The fraction of the retirement pension that has accumulated
up to age x, expressed as a unit salary bill at entry, and its likely present value at age
x, is given by:
x − b lxa Sx −γ(r−x) lra p(δ−β)
F (x) = e a¯ (2.14.84)
100 lba Sb lxa r

33
which, after simplification, yields, in terms of commutation functions,
a(δ)
x − b (γ+δ)(x−b) Sx Dr
F (x) = [e ] a(δ)
a¯rp(δ−β) (2.14.85)
100 Sb Db

Multiplying both sides by e−δ(x−b) differentiating both sides with respect to x and
substituting yields the following expression for K(x):
a(δ)
1 Dr Sˇx
K(x) = a(δ)
[1 + (x − b)( + γ)]a¯rp(δ−β) (2.14.86)
100 Dx Sx
The above expression can be interpreted by considering the contribution amount K(x)
dx in the interval (x, x + dx) per unit of current salary. The part within the square
brackets times dx would represent the increase in the pension rate (as a percentage
of the current salary) in the interval, which has two components.

2.14.3 Entry Age Cost Method

Entry age methods (also called projected benefit methods) seek to establish a level
contribution rate or amount in function of the entry age. In this case K(x) = K(b)
at all values of x. From the equation of equilibrium above the following expression is
obtained:
as(δ−γ)
r − b Dr
K(b) = a¯p(δ−β) (2.14.87)
100 r Dxas(δ−γ) dz r
R
b
which can be expressed as
as(δ−γ)
r − b Dr
K(b) = as(δ−γ)
a¯rp(δ−β) (2.14.88)
100 N¯b
where Z r
N¯as(δ−γ)
x = Dzas(δ−γ) dz (2.14.89)
x

Assuming that the experience coincides with the initial assumptions, the reserve fund
function will then be given by:
Rx as(δ−γ)
δ(x−b) b
Dz dz
F (x) = e K(b) as(δ−γ)
(2.14.90)
Db

34
which can be expressed as
as(δ−γ) as(δ−γ)
N¯b − N¯x
F (x) = eδ(x−b) K(b) as(δ−γ)
(2.14.91)
Db

2.15 Chapter Summary

The chapter presented the literature review pertaining to survival of pension schemes
during periods of hyperinflationary in Zimbabwe. The literature also focused on
credible sources peer reviewed sources such as journals, books, articles and other
published papers. The literature review also established the empirical and theoretical
framework of the study through articulation of some of the mathematical structures
of different models.

35
Chapter 3

Methodology

3.1 Introduction
The chapter presents the research methodology that will be used in the study in the
analysis of the of survival of insurance and pension schemes during periods of hyper-
inflationary in Zimbabwe. The chapter will explore some of the analytical procedures
that shall be utilized in the data analysis, the chapter will also allude to data descrip-
tion in which the data will be described that is in terms of the research participants.
The chapter will also discuss, the software that shall be used in the study during data
sorting and analysis.

3.2 Data Description

The research data consist of seven variables that is inflation rate, claims amount, type
of the claims, gender of the participants, securities, investment returns and risk levels.
The inflation rate will be measured on a monthly basis in which it will be aggregated
to different policy holders. Claims amount consist of the number of claims that would
have been made in a particular month of interest, where these claims will assist in
determining their response of increase or decrease in inflation. Type of claims, consist
of a binary indicator in which whether a policy holder subscribed to life or non-life

36
insurance. Gender of the participants consists of either a policy holder is male or
female, as it will help in understanding the demographic patterns within insurance
and pension schemes. Meanwhile, securities, investment returns and risk levels will
allude to portfolio-selection modelling.

3.3 Analytical Procedures

The research study will utilize a number of techniques in order to determine the most
suitable modelling technique that can accurately analyze the influence of inflation
rates on insurance and pension industry.

3.4 Descriptive Statistics

It is very important that the developed descriptive statistics that describes the data
used in the model. The following methods will be used; bar graphs, and line charts
will be used.

3.5 Analytical Procedures

The research study developed will develop a Functional Demographic Model, making
use of Vector Autoregressive model, and then assess the model parameters using
Akaike Information criterion. Furthermore, with the developed model, the study will
project the death rate and make life expectancy projections. The fitted model will
be examined for its goodness of fit on the age groups of the participants. Moreover,
using the obtained information as established above, the research study will also fit a
Lee Carter Model to aid in the analysis of life expectancy and mortality of different
age groups in the data. This in turn will depict the fertility rate which also assist
policy makers and making future adjustments to population changes.

37
3.6 Softwares to be used
The research study will utilize a number of software in order to attain the research
objectives. In this regard, the study will use Tex Studio in typesetting the research
study together with figures and tables. The research study will also make use of
R Studio in performing the analysis towards achieving research goals. The research
study will also make use of STATA as one of the analytical software.

3.7 Chapter Summary

The chapter presented the research methodology that will be used in the study in
the analysis of of the survival of insurance and pension schemes during periods of
hyperinflationary in Zimbabwe and as well as the application of mortality models in
pension funds design. The chapter explored some of the analytical procedures that
shall be utilized in the data analysis, the chapter also alluded to data description in
which the data will be described that is in terms of the research participants. The
chapter also discussed, the software that shall be used in the study during data sorting
and analysis.

38
Chapter 4

Data Analysis and Results

4.1 Introduction
The chapter shall present the data analysis that was carried out on the application of
mortality models in pension funds design. The research analysis will present the data
analysis with firstly examining the descriptive statistics pertaining to the variables in
the data set. Furthermore, the chapter will present the findings through the use of
figures and tables to aid in the explanation of inferences.

4.2 Descriptive Statistics

The research study will present the outlook of the data through descriptive statistics
that also includes graphical presentation of data. The descriptive statistics will also
include exhibits obtained from R-Studio. The following Figure 4.1 shows the gender
of participants whose data was used in the study.

39
 Figure 4.1. Gender of Participants

The output presented on the Figure 4.1 shows the gender of the participants. It shows
that females were dominating than males. The output presented on the Figure 4.2
shows the age groups of the participants that were used in the study.
Figure 4.2. Age Group of Participants

The Figure 4.2 shows that there is high birth rate as children are dominating in the
data set. Furthermore, it shows that the number of people making it to the next
age group are decreasing which may be attributed to deaths, and migration to other

40
various countries. Moreover, the following output presented on the Figure 4.3 shows
the age group and its corresponding death rate.

Figure 4.3. Age Group and Death Rates

The Figure 4.3 shows the age groups of participants and their respective death rate.
The presented age groups are as follows: 0 to 10yrs; 11 to 20 years; 21 to 30 years;
31 to 40 years; 41 to 50 years; 51 to 60 years; and 60+ years. The depicted figures
of mortality shows that there is high death rate in infants, or rather high infant
mortality. The death rate shows that it is high in infants and as well as in the aged
population meanwhile it is low for the middle aged people especially those aged 31 to
40 years. This particular section allude to the overview that pertains to the research
variables in the model. Furthermore, the Figure 4.4 shows the summary statistics of
the variables in the model.

Figure 4.4. Main effects,Interaction and Coefficient

41
The Figure 4.4 shows the Main effects, Interaction and Coefficient in the data set.
From the Figure 4.4, it is clear that main effects increases with age and the interaction
is monotonic decreases with age.

4.3 Functional Demographic Model

The research study developed a functional demographic model for the population of
Zimbabwe in order to depict the direction towards which the population numbers were
taking. Furthermore, the information will be utilized to construct population death
rate projections by age and as well as the forecasting the life expectancy. The output
presented on the Figure 4.5 shows the developed functional demographic model for
Zimbabwe:

42
 Figure 4.5. Functional Demographical Model

The Figure 4.5 shows the functional demographic model in which the mean square
error across ages is 0.05686 and across years 0.73512 which is very small.

4.4 Projecting Death Rate

Furthermore, making use of the data set obtained from World Bank on population
death rates projections dating back to 1816 for Zimbabwe, the following plot presented
on Figure 4.6 shows the death rates projections for Zimbabwe up to 2056.

43
 Figure 4.6. Death Rate Projection

The Figure 4.6 shows the projections of death rate from 1816 to 2056. From the
Figure 4.6, it is clear that the death rates are increasing with age.

4.5 Life Expectancy Projection

In order to determine the number of years that Zimbabwe population is expected to
live right from birth, life expectancy reveals the average age that a person is likely
to live. The output presented on Figure 4.7 shows the fitted model life expectancy
projection.

44
 Figure 4.7. Life Expectancy Projections

The Figure 4.7 shows the life expectancy population projections that were fitted for
the Zimbabwe population. Although the fitted model tend to overestimate the life
expectancy, in real life it is actually lower.

4.6 Forecasting Accuracy

It is important to depict the forecasting accuracy of the developed model in which,
the outputs below shows the error measurements by the age groups in which the
forecast was performed. This is as presented on the Figure 4.8

Figure 4.8. Forecasting Accuracy

The Figure 4.8 shows that the forecasting accuracy was very high at the age groups

45
between 20 years and 40 years. Meanwhile, it was very low for the age groups that
are above 100 years of age.

4.7 Forecast coherent functional demographic model

While the research study aims to make inferences from the demographic and mortality
models in relation to pension funds, it is also important to determine the demographic
structures presented through different techniques and as such, the study will forecast
the coherent functional demographic model. The output presented on Figure 4.6
below shows the product model of the developed functional coherent demographic
model.

46
 Figure 4.9. Product Model of the coefficients in the model

The figure 4.9 shows the product model of the coefficients 1 to 4 , meanwhile the

47
output figure 4.10 shows the coefficients from 5 to 7.

Figure 4.10. Product model Coefficients 5 to 7

4.8 Lee Carter Mortality Tables

The research study proceeded to construct life tables under Lee Carter procedure to
determine the life table for 2023 as it is the closest year of interest towards insights into
pension schemes. The Figure 4.8 shows the mortality tables for Zimbabwe population.

48
 Figure 4.11. Lee Carter Life Tables

The Figure 4.11 shows the Lee Carter life table model which was developed from the
age 10 to 38 meanwhile the following tables are from 39 to 76 years.

Figure 4.12. Lee Carter Life Tables

49
The Figure 4.12 shows the constructed life table form from 39 years to 76 years,
meanwhile the Figure 4.13 shows the results from 75 to 100 years.

Figure 4.13 (Lee Carter Model Life Tables).

50
The Figure 4.13 shows the constructed life table form from 75 years to 100 years.
Furthermore, so as to aid to the Lee Carter Model life tables, the research study
developed and forcasted Zimbabwe fertility rates so to further ascertain the impacts
on social services scheme. This is as presented on the Figure 4.14:

Figure 4.14. Fertility Rate Forecast

51
The Figure 4.14 shows the forecast of the fertility rate in Zimbabwe. Fertility rate
will assist in preparedness of the responsible authorities to make available necessary
resources that are needed for furthering the pension funds as more people will rely
on it.

4.9 Chapter Summary

The chapter explored the data analysis that was carried out on the application of
mortality models in pension funds design. The research analysis also presented the
data analysis with firstly examining the descriptive statistics pertaining to the vari-
ables in the data set. Furthermore, the chapter also presented the findings through
the use of figures and tables to aid in the explanation of inferences.

52
Chapter 5

Conclusions and Recommendations

5.1 Introduction
The research study presented and discussed various issues pertaining to the study on
the application of mortality models in pension funds design. The chapter is founded
on the need to further discuss the findings as presented in the chapter earlier. Further-
more, the chapter will present the discussion based on the other chapters that that
they have covered. The chapter will also proceed to present the research recommen-
dations that can be derived from the findings of the study to different stakeholders.

5.2 Discussion of the Findings

Applications for stochastic simulation models in life and pension insurance are sig-
nificant. They are utilized in pension liability estimation, risk management, asset
allocation, pricing, and hedging of longevity-related products. The Wilkie model and
those of Tillinghast Towers Perrin (Noorman, 2018) for actuarial usage globally are
arguably the two most well-known stochastic models in the context of pensions. The
majority of life and pension insurers are heavily exposed to mortality and longevity
risk, even though the aforementioned are risk factors related to the economy and
finances. Additionally, this has stimulated the active creation of stochastic mortality

53
models in recent years; yet, the majority of models continue to be disassociated from
the financial and economic risk factors. The study findings provided a broad founda-
tion for building stochastic simulation models of the assets and longevity-linked lia-
bilities of a typical pension or life insurance under hyperinflationary conditions. The
approach took into account longevity risk in addition to the primary asset classes
employed by pension funds: corporate bonds, index-linked bonds, short-term and
long-term fixed-rate bonds, and stocks. The model took into account the sometimes
overlooked connections between lifespan and the economy. Such linkages are crucial,
for instance, in the assessment and hedging of liabilities and goods with long-term
lifespan links. Even weak statistical links in long-dated obligations may allow for par-
tial hedges with significant impacts on valuations and risk management. The mod-
eling technique also enables the integration of projections or user perspectives that
are compatible with the statistical parameter estimations. In many circumstances,
where previous data does not provide the greatest depiction of the future, this trait
is essential. The previous research works on asset and liability modeling in the litera-
ture serve as the foundation for the current study. The stochastic model, like Pelsser
(2019), incorporates statistical relationships between lifespan and the economy. In
this research project, the linkages were used to build a comprehensive asset and lia-
bility simulation model, where the relationships influence returns in a number of asset
classes. By utilizing just one or two risk variables, the reduced form model for bond
portfolio returns provides accurate explanations of returns even for enormous bond
portfolios. All at hand, it can be deduced that hundreds of risk variables that influ-
ence the assets and liabilities of a typical pension fund. Fortunately, it is frequently
possible to significantly reduce the number of risk variables while maintaining the
key characteristics of the distributions of asset returns and responsibility payments.
Finding the most pertinent risk variables that have an impact on the quantities of
interest is the first stage in developing any stochastic model. The investment returns

54
in various asset classes and the pension spending are the interesting numbers in the
context of managing pension funds. The longevity, price, and salary inflation that
are frequently employed in the indexation of defined benefit obligations are the most
significant sources of uncertainty on the liability side. There are additional macroe-
conomic risk variables, such as the GDP, that might indirectly influence the returns
on investments or obligations.

5.3 Conclusion
In conclusion the research study firstly described the data making use of descriptive
statistics that is through graphical presentation of data. The research findings on
gender revealed that females were dominating than males and that the age groups
was skewed to the right meaning that the majority of the people were young people
and there was less number of the aged people. The comparison of age groups with the
respective death rates revealed that there was high mortality in the younger people
and those that were above 60 years of age. Furthermore, it was discovered that there
was less mortality in middle aged people. The research study proceeded to construct
a functional demographic model making use of Vector Auto Regressive models. The
research study then proceeded to infer predictions on the projected death rate and
life expectancy. It was uncovered that death rate will decrease and life expectancy
increase with time up to the predicted year of 2050. Moreover, in order to increase
the accuracy of the first model, another functional demographic model was fitted in
which it had the best Akaike Information Criterion. Moreover, the study fitted a Lee
Carter Model depicting the life tables and further plotted a fertility rate forecast.

55
5.4 Recommendations
The research study uncovered a number of recommendations that can be used in the
study, these are listed as below:

• This work aims to stimulate reflection on the benefits that these creating more
effective in practice could carry to the quantification of longevity risk rather
than going into detail considerations of the stringent regulatory aspects due to
the advent of Classification technique in the insurance sector. There is need
to develop a database that can be used for retrieving information as pool that
will be reliable as compared to unverified sources that provide data set. This
database will form a foundation in data collection and management in the field
of statistics and actuarial science.

• For further studies it is recommended to make use of other demographic vari-

ables that includes the Gross Domestic Products; Interest rate; exchange rate
and inflation rate. Furthermore, this can be done through situating the variables
such as socio-economic factors such as the income levels of participants.

5.5 Limitations
However, utilizing mortality tables to make distinctions based on socioeconomic po-
sition and gender has its own issues because it might result in discriminatory issues.
The use of average life expectancy penalizes those with greater life expectancy (such
as women, those with higher education levels, and those with higher incomes) while
favoring those with lower life expectancy (e.g men, low educated and low income
people) is one argument in favor of differentiating tables. The private pension scheme
would however need to hedge against their own longevity risk i.e risk associated their
membership structure, instead of their average longevity risk which we took into

56
account for the population of Zimbabwe.

57
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Appendix 1

Figure 5.1.

62
Figure 5.2.

63
Figure 5.3.

64
Figure 5.4.

65
Figure 5.5.

66
Figure 5.6.

67
Figure 5.7.

68
Figure 5.8.

69
Figure 5.9.

70
Figure 5.10.

71
Figure 5.11.

72
Figure 5.12.

73
Figure 5.13.

74
Figure 5.14.

75
Figure 5.15.

76
Figure 5.16.

77
Figure 5.17.

78
Figure 5.18.

79
Figure 5.19.

80
Figure 5.20.

81
Figure 5.21.

82
Figure 5.22.

83
Figure 5.23.

84
Figure 5.24.

85
Figure 5.25.

86
Appendix 2

Figure 5.26.

87
Figure 5.27.

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88