What will happen when pensions are no longer paid?

We need more stable investments. Aivars Lode

Asia News

11 May 2012

We’re living much longer than anyone planned for. Investment firms have been preaching this for some time, instructing people to invest more money, more aggressively, to account for their longer spending lives.

Melinda Howes, chief executive officer of the Actuaries Institute, thinks we need to step back and get a clearer idea of how this will change business and society, because longevity will rock more than the financial industry.

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Howes says the financial industry and society in general has badly underestimated how long we’ll live, and the impact of that longevity. We haven’t been very good at predicting longevity until now. In 1977 UK actuaries predicted life expectancy for UK males would be about 71 years as of 2010. It was more than 77 years.

Much of that is because medical science has been developing rapidly and producing cures, preventions and treatments that we could not dream of in the 1970s. Human genome discoveries, a huge drop in the number of people who smoke – resulting in few cases of heart disease and respiratory problems, stem-cell research, targeted therapies for some types of cancer, drug treatments for HIV and minimally invasive surgery methods. The list goes on, and each development contributes significantly to creating an older population. Cancer is the only main disease still claiming much the same number of lives as it did one century ago.

Mortality is different for different socio-economic groups. Those with more education, money and white-collar jobs live longer than the men working in the trenches. As global wealth and education increases longevity in developing countries will improve. “If they find a cure for cancer our life expectancies would jump significantly almost immediately.”

Howes predicts we’re coming close to big scientific breakthroughs that will push longevity out even further, creating a scenario that no one is prepared for. This creates major risk issues for the financial industry, and our regular risk models, which are geared towards compliance rather than business strategy, will fail us.

“This is our next black swan event,” Howes wrote in a recent research paper titled Living Until 120. “This is something enterprise risk managers need to be paying very careful attention to, to see what the implications are going to be for your organisation.”

Enterprise risk management creates forecasts for different potential scenarios, rather than just looking at an organisation’s compliance risks. It prepares a company to be ready for those situations, allowing it to react more quickly to major changes.

While most investment professionals use this information to challenge people to think about keeping their money in equity longer rather than shifting to fixed income, Howes takes it a step further.

“How much of a person would need to be replaced before they are counted as legally dead and can collect their life insurance?” she asks. “If you live beyond 120 as a brain in a vat, fully conscious and able to communicate and participate in life online and in virtual reality, are you still eligible for lifetime annuity payments?”

Longevity has clear implications for pension funds, as the Baby Boomer generation starts to draw benefits. The most recent Australian Prudential Regulatory Authority (APRA) statistics from 2010 show us that 10 percent of members in APRA regulated funds are aged 60-plus, and those members aged 60-plus hold 33 percent of assets. This means that these accounts are already in outflow, or will start to be drawn down in the next five years.

However, governments and other organisations will face more complex problems related to the recent global financial crisis, longevity and other shifts in society, such as healthy people being expected to, and sometimes forced to by finances, to work far beyond their expected retirement age.

Howes points to the entitlement culture, where people expect that because they have paid their taxes they are entitled to a government funded pension and health care in retirement. In our lifetime there may well be two generations paying for two post-retired generations and then potentially two paying for three. There are already protests in the streets of Europe over planned austerity measures. What will happen when pensions are no longer paid?

The global financial crisis seriously eroded trust in financial promises made by financial institutions, or government. This will only worsen. There will be a lack of trust in the modern welfare system in particular.

This will mean that investors want quick escape routes from products. They won't want to be tied to any product or provider, such as an annuity provider or capital guaranteed underwriter.

Howes argues the actuarial profession is the one that really understand profits, capital and risk management, and that they need to step up to the frontlines of business rather than work behind the scenes.

“We need to position ourselves as the profession that saw the change coming and were able to build models and develop assumptions that stress tested various likely outcomes,” she said.

Author: Cameron Dueck