Perspectives on longevity are like Schopenhauer’s glass. You see it half full if you look forward to a healthy and active retirement. Or half empty if you are concerned about fragility, decline in cognitive abilities and deterioration of the body.
But, assuming you stay healthy, long life would seem to be a cause for rejoicing? Judging from the language of actuaries, economists and retirement professionals, perhaps not.
Since Biblical times, old age has been coveted, yet terms like “toxic tail,” “mortality rates” and “longevity risk” cast a pall over the fact that average life expectancy is now 67 years. “Economics is called the dismal science with justification,” says Dr. David Blake, professor of pension economics at
Cass Business School in London and the director of the Pensions Institute. “We believe you have to ask tough questions to make it clear what the choices are. When it comes to pensions, the language reflects the perspective – do you treat longevity as an asset or liability?”
GLOBAL LIFE EXPECTANCY
Global life expectancy has risen from an average of 45 in the 1950s, thanks to advances in medicine, plus improved nutrition and health. Western countries all lie well above the global average. (Japan is highest, at 82.6 years, according to the UN World Population Prospects 2006.) Longevity is improving linearly by three months every year with no sign of tailing off, so average global life expectancy could reach 75 years by 2050.
Glass-gazing aside, studies show people who live longer do not necessarily suffer many more years of ill health. The
2006 English Longitudinal Study of Ageing (July 2008) said data contrasted for the period from 2001 and 2004 suggested an increase in healthy-life and disability-free life expectancy for older people. A General Household Survey conducted in 2000 for the Office for National Statistics in the UK revealed 80% of those aged 80 to 90 do not have dementia and 85% to 90% do not suffer depression. The results imply a fairly fit, capable and active older population, while Robin Blackburn reported in Banking on Death (Verso 2002) that the results of over-60 Olympic runners in 1998 matched those of Olympic winners in 1898.
Now people are retiring at 65 and living up to 30 more years. You have to ask, how can this be funded? David BlakeYet, exactly because we are likely to live longer and be healthier, Dr. Blake suggests individuals and economists ask another question apart from “Is the glass half full or half empty?” Rather, “Who’s picking up the tab?”
“Retirement is largely a 20th-century invention. Previously people did not retire but worked until they dropped. This changed when enlightened employers began paying a gratuity as a reward for long and loyal service. This gradually turned into a promise, the promise into an entitlement and then finally into a guarantee. Now people are retiring at 65 and living up to 30 more years. You have to ask, how can this be funded?”
Funding of retirement is a central question confronting modern societies. Increased longevity offers individuals a potentially longer period to enjoy their time on earth. But it also could cause individuals to outlive their assets, reduce their standard of living or even fall into old-age poverty.
Improved longevity also concerns policy-makers, insurance companies and pension funds in countries where demographics are running against state pay-as-you-go (PAYG) pensions schemes. These countries are also aging due to reduced fertility, with the number of children being born falling below the replacement rate of 2.1 per female that is needed to stabilize the population. More elderly and fewer babies means the old-age dependency ratios (the number of people age 65 and over per 100 people of working age) are expected to rocket in the next decades placing substantial financial stress on PAYG systems.
UNKNOWN FUTURE LIFE EXPECTANCY
also affects pension funds and annuity providers. They run the risk that the net present value of payments may turn out higher than expected, and that they may have to pay out for a longer than estimated life span. Estimates included in Unknown future life expectancy The Purple Book from the UK Pensions Regulator suggest one extra year of life expectancy at the age of 65 adds 3% to the value of pension liabilities, and five years adds a total of 13%. “If you have to provide a company pension and you haven’t put enough aside, if your liability is bigger than what you planned for, there is a stark choice between making good the pension deficit, on the one hand, and paying dividends and maintaining the company’s investment program, on the other,” explains Dr. Blake.
Longevity unknowns impact the value of future pension liabilities. Those providing pensions need to address this, but OECD economist Pablo Antolín suggests most pension funds do not fully account for future improvements in mortality and life expectancy. Referring to his report (2007), Antolín says, “Pension funds in some countries incorporate an allowance for expected future improvements in mortality, while others use tables that relate to mortality observed over a period in the past, without allowing for the fact that life expectancy may continue to increase.” He notes countries such as Canada, Finland and the US have “mortality tables with built-in mechanisms to take into account future changes in mortality,” but tend not to use them.
Dr. Blake argues it is essential that pension funds and states come to terms with longevity risk, even if it is uncertain. He has been instrumental in developing an innovative stochastic mortality forecasting model. Known as the Cairns-Blake-Dowd (CBD) model, it forecasts future longevity, but also quantifies the uncertainty surrounding longevity and illustrates this uncertainty using fan charts.
“With this model, we can show how the value of pension liabilities is linked to increases in survivorship. This is important because even though fund managers might generate good investment performance, life expectancy could increase more than expected, resulting in an unplanned pension deficit, despite that performance.”
Not just of value to professionals, such tools could also help individuals plan for old age more prudently. While a longer life may be good news, the related unknowns will require individuals to assume greater responsibility for funding their retirement. This not only implies a more active involvement in the accumulation phase, but also during the lengthening decumulation phase so as to ensure their own financial well-being over the life cycle.
Thought Leader Profile
David Blake is a professor of pension economics at Cass Business School, City of London, and founder and director of the Pensions Institute, a pensions research organization. He is also Chairman of Square Mile Consultants, a training and research consultancy. Dr. Blake has written several books and numerous articles on pension economics and finance. In his research, he has several areas of interest including the modeling of longevity risk, the investment behavior and performance of pension funds and mutual funds, pension plan design, and mortality-linked securities.