Prepare to live longer

Increasing longevity continues to present challenges for those planning their retirement. Bernard Footitt discusses some of these issues

"And all the days of Methuselah were nine hundred and sixty and nine years: and he died" (Genesis 5:27 - American Standard Version). To which I say "I should think so!" Seriously though, increasing longevity brings more and more challenges to the world, and not least the pensions world.

Let's examine some aspects of increasing longevity, the impact on people, pension providers and government as well as some indicative data.

Longevity

The United Nations population forecasts, 2004 predicted the following:

- By 2005, 51% of the UK's population would be 50 or over;

- By 2010 this would rise to 54%;

- By 2015 this would rise to 59%; and

- By 2020 this would rise to 63%.

Last August, the Office for National Statistics (ONS) reported that there are "more pensioners than under-16s for the first time ever". The reasons cited for this are "partly due to the number of women born in the immediate post World War Two baby boom" and the "decreasing levels of mortality for older ages since the 1950s". In addition, the ONS reported elsewhere that "the proportion of the population aged under 16 is declining due to sustained low fertility".

Another ONS publication from August 2008 also pointed out that "the fastest growing age group in the population are those aged 80 years and over" and "the rising number of centenarians is due to increased survival between the age of 80 and 100".

Having spent time over the last two years at numerous conferences and seminars to do with pensions, I am intrigued by some of the projections and data collated by Life Trust. Firstly, Professor Thomas Kirkwood (Professor of Medicine and Director of the Institute of Ageing and Health at the University of Newcastle) postulates that "life expectancy in the UK is currently increasing at a rate of five hours every day" while Mike Lake CBE is quoted by Life Trust in May 2006 as saying "longevity is becoming one of the major issues for Western Society".

However, there are some people who think that increased longevity on this scale is over for the 'chicken nuggets and playstation generations (!)'.

However, the key mortality issue now appears to be understanding whether improvements will continue to accelerate or whether we have reached some kind of turning point where the parents of the new obese generation may possibly outlive them.

People

What we are really talking about here is people and the impact that increasing longevity will have on their retirement income.

Firstly, we can see the UK Government has already discounted their ability to sustain state retirement provision for a much longer period, and potentially extended longevity is truly becoming the largest dilemma for the developed world.

The UK has already increased State retirement ages (SRA): females are already being affected by the upwards levelling of SRAs with those born on or after 6th April 1950 being just over a year away from an increase in SRA beyond the age of 60. Between 2024 and 2046 there will be progressive increases in SRA to 68 with every one born after 5th April 1959 being affected.

The other major impact of increased longevity is annuity rates, and this, combined with the loss of final salary defined benefit schemes, means a money purchase defined contribution pension pot will have to be eked out over a longer period. Therefore for a 65 year old today it could realistically be 30 years (13.7%) and fairly certainly, for 59% of males, 20 years. For females, these periods represent 26% and 69.9% chances of survival respectively. These calculations come courtesy of the Life Trust - Longevity Calculator.

Providers

You have to feel a bit sorry for providers and their actuaries, don't you? Not only are they wrestling with the impact of increased longevity, but also with falling annuity interest rates. Add to this the lack of individual pensions savings pots coming on stream, then it's little wonder that most private pension provision is small.

Certainly the so-called 'cohort effect', while not now irrelevant, is less important than it was say five years ago.

However, the Continuous Mortality Investigation Library, first published on 22nd November 2007, has been a great help to providers as it contains at least 55 different mortality projections.

Pressure continues to be placed on life companies as illustrated by the FSA "Dear CEO" letter in April 2007 that said "We think most firms currently use the medium cohort projection as their valuation basis, often with a minimum level of mortality improvement. (...). We are concerned that ... (some) firms may not be giving sufficient weight to the possibility that their policyholders may live longer than expected."

Pension funds are also feeling the squeeze with reduced capital values and peer pressure, for example, "We encourage all (pensions) actuaries to compare recent experience with the future rates of improvement within any projections they are considering recommending." (Presidents of the Institute & Faculty of Actuaries - July 2007).

The overall impact is that all pension pots have to stretch much further than they used to.

Summary

In October 2008, Fidelity Retirement published their research on "The nature of financial risk in retirement" where five key financial risks in retirement were identified:

1. Longevity risk - the risk of your money dying before you do;

2. Inflation risk - inflation diminishing your pension over the years;

3. Asset allocation risk - what is the best mix of any investment pot from which you are drawing your income directly;

4. Withdrawal risk - the risk of withdrawing too much income too quickly;

5. Liquidity risk - how will I pay for any long-term care should I need it.

The researchers found that people most wanted to eliminate or at least mitigate longevity and liquidity risks while they felt they could exert some control over asset allocation and withdrawal rates. Inflation they could live with.

What was also demonstrated was that only annuities, in one form or another, could eliminate the longevity and liquidity risks.

It's self evident that conventional and enhanced lifetime annuities do this absolutely as the income is guaranteed for life.

However, even low inflation can have a massive effect on a level annuity over 20 or 30 years of retirement. In addition, someone taking their annuity at say 65 has no further opportunity to adjust what has been arranged at outset even if they become single again or fall into poor health later in life.

The market has made some response to this by adding a degree of flexibility into annuities by producing hybrids of a conventional annuity. For example, the pensions regulations that determine the amount of annuity that can be paid can follow a particular route to allow changes to be made after initial annuitisation. This is but one example of a provider being able to use the regulations and responding to minimise the impact of increased longevity.

State and private provision

All in all, the major impact of increasing longevity begins with State provision and the ability of the State to pay benefits for this extended period of time. Being pay-as-you-go, the demographic shifts in population mean that there are less people of working age and paying national insurance contributions trying to support a growing, longer-living retired population.

On the private provision side, DB or DC schemes also have to pay benefits for a much longer period of time. Additionally, with those personal DC schemes, the fund in unsecured pension/alternatively secured pensions may benefit from lower GAD based interest rates, however the fund has to last longer. This also brings about investment return difficulties over the long-term especially where 100% or more of the GAD reference rate is withdrawn for long periods of time.

When exchanged for an annuity income, the challenges of increased longevity and lower annuity interest rates requires a very delicate balancing act to be delivered by a provider's pension actuaries.

Finally, increased longevity requires back-up resources, for example deposit interest, equity dividends, equity release, guaranteed unit-linked investment bond (5% for life) and so on to deliver income in retirement over the long-term. If you don't have any of these income sources or not very many, the answer is some form of secured pension, that is an annuity of some sort.

¹ Steve Groves FIA - December 2007