Project – Assessment of Longevity Risk and Its Impact on Pension Fund Sustainability in Nigeria’s Contributory Pension Scheme

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Pension systems play a critical role in ensuring income security for individuals after retirement and in maintaining social stability within any economy. Globally, pension schemes are designed to pool and manage long-term savings in order to provide periodic benefits to retirees. However, one of the most significant challenges confronting modern pension systems is longevity risk, which refers to the risk that pensioners live longer than expected, thereby increasing the duration and total cost of pension payouts (Blake, Cairns, & Dowd, 2006).

In actuarial science, longevity risk is considered a major demographic and financial risk because it directly affects the sustainability of pension funds. When life expectancy improves beyond projected mortality assumptions, pension funds face increased liabilities, which can threaten their long-term solvency (OECD, 2020). Developed countries such as the United Kingdom, United States, and Japan have implemented sophisticated actuarial models such as stochastic mortality forecasting, survivor indexes, and longevity bonds to manage this risk effectively.

In Nigeria, the introduction of the Contributory Pension Scheme (CPS) under the Pension Reform Act of 2004 (amended in 2014) marked a significant shift from the unfunded defined-benefit system to a fully funded contributory system managed by Pension Fund Administrators (PFAs) and Pension Fund Custodians (PenCom, 2023). The CPS was designed to improve transparency, reduce corruption, and ensure long-term sustainability of retirement benefits.

Despite these reforms, the Nigerian pension system still faces structural and actuarial challenges. One of the emerging concerns is whether current actuarial assumptions adequately capture longevity improvements among retirees. Improvements in healthcare access, awareness of wellness, and gradual socio-economic changes suggest that Nigerians may be living longer than earlier actuarial projections assumed. This creates a potential mismatch between pension contributions and long-term benefit obligations.

Furthermore, inflationary pressures, volatile investment returns, unemployment rates, and informal sector dominance also compound the pressure on pension fund sustainability in Nigeria. While PFAs rely on actuarial valuation models to forecast liabilities, there is limited empirical evidence on how accurately longevity risk is being incorporated into these projections within the Nigerian context.

Therefore, assessing longevity risk and its impact on pension fund sustainability is critical to ensuring that the Contributory Pension Scheme remains viable, adequately funded, and capable of meeting future obligations.

1.2 Statement of the Problem

The sustainability of Nigeria’s Contributory Pension Scheme depends largely on the accuracy of actuarial assumptions used in estimating future pension liabilities. One of the most important assumptions is mortality and life expectancy projection. However, there is growing concern that longevity risk is not being sufficiently captured or accurately modelled in the Nigerian pension system.

Although the CPS was introduced to address the failures of the defined-benefit system, pension fund sustainability challenges persist. Pension Fund Administrators often rely on historical mortality tables and generalized actuarial assumptions that may not reflect current improvements in healthcare, lifestyle changes, and demographic transitions in Nigeria. As a result, retirees may live longer than projected, leading to higher-than-expected pension payouts and increased long-term liabilities.

In addition, Nigeria’s limited availability of updated mortality data and weak actuarial data infrastructure further complicates accurate longevity forecasting. This creates uncertainty in pension liability estimation and exposes pension funds to potential solvency risks in the long run. If not properly managed, longevity risk could erode accumulated pension assets and undermine confidence in the CPS.

Moreover, most existing studies on pension sustainability in Nigeria focus on governance, investment performance, and regulatory compliance, with less emphasis on actuarial longevity risk modelling. This represents a significant research gap.

Therefore, the problem this study addresses is the insufficient assessment and integration of longevity risk in pension fund sustainability analysis within Nigeria’s Contributory Pension Scheme.

1.3 Objectives of the Study

The main objective of this study is to assess longevity risk and its impact on pension fund sustainability in Nigeria’s Contributory Pension Scheme.

The specific objectives are to:

1. Examine the extent to which longevity risk is incorporated into actuarial valuation of pension funds in Nigeria.
2. Evaluate the impact of life expectancy trends on pension fund liabilities under the Contributory Pension Scheme.
3. Assess the relationship between longevity risk and the financial sustainability of pension funds in Nigeria.
4. Determine the effectiveness of current actuarial models used by Pension Fund Administrators in managing longevity risk.

1.4 Research Questions

1. To what extent is longevity risk incorporated into actuarial valuation in Nigeria’s pension system?
2. How do life expectancy trends affect pension fund liabilities under the CPS?
3. What is the relationship between longevity risk and pension fund sustainability in Nigeria?
4. How effective are current actuarial models in managing longevity risk in Nigeria’s pension sector?

1.5 Research Hypothesis

H₀ (Null Hypothesis):
There is no significant relationship between longevity risk and the sustainability of pension funds in Nigeria’s Contributory Pension Scheme.

H₁ (Alternative Hypothesis):
There is a significant relationship between longevity risk and the sustainability of pension funds in Nigeria’s Contributory Pension Scheme.

1.6 Significance of the Study

This study is significant in several ways. First, it will contribute to actuarial science literature by providing empirical insights into longevity risk in a developing economy context. Second, it will assist Pension Fund Administrators in improving actuarial valuation models and risk management strategies.

Third, the findings will be useful to the National Pension Commission (PenCom) in strengthening regulatory frameworks for pension sustainability. Additionally, policymakers will benefit from the study in designing reforms that ensure long-term pension security.

Finally, the study will serve as a reference for researchers and students in actuarial science, finance, and risk management.

1.7 Scope of the Study

This study focuses on the assessment of longevity risk and its impact on pension fund sustainability in Nigeria’s Contributory Pension Scheme. It examines actuarial assumptions, life expectancy trends, and pension fund liability sustainability within Nigeria. The study is limited to available secondary data, actuarial reports, and relevant pension statistics in Nigeria.

1.8 Operational Definition of Terms

Longevity Risk: The risk that pensioners live longer than expected, increasing pension liabilities.

Pension Fund Sustainability: The ability of pension funds to meet long-term obligations without financial distress.

Contributory Pension Scheme (CPS): A pension system where both employer and employee make mandatory contributions into a retirement savings account.

Actuarial Valuation: A mathematical assessment of future pension liabilities based on demographic and financial assumptions.

Life Expectancy: The average number of years a person is expected to live based on statistical models.

Project – Assessment of Longevity Risk and Its Impact on Pension Fund Sustainability in Nigeria’s Contributory Pension Scheme