Longevity Risk: Living Longer And The Increasing Retirement Burden
Centenarians – those individuals who reach 100 years of age or more – used to make headlines. Living to 100 years used to be a somewhat rare occurrence, but recent research indicates that babies born today could expect to exceed 100 years of age on average. Such changing demographic patterns are significantly altering how governments and the private sector forecast health care spending and account for their future pension liabilities. When you consider that social safety programs, such as the Medicare and Social Security programs in the U.S., were designed to start taking care of people at around 65 years of age, the ever-increasing life expectancy around the world is already causing strain. With a retirement gap, the difference between pension fund obligations and the assets available to fulfill them are some $1 trillion – and longevity risk continues to add to the gap.
Such dynamics have far-reaching implications for pension planning – especially for employers. Roselyn Feinsod, senior partner and U.S. regional practice leader, Retirement at Aon, notes: “organizations are managing their pension and retirement obligations, while at the same time, helping their employees – who now largely own the retirement savings burden – plan for the future.”
Still, when even modest swings in life expectancy can translate into new obligations that total in the billions of dollars, governments and companies are eager to understand how to safeguard their pensions and ensure they have sufficient funds to meet obligations.
According to data from the World Health Organization, global life expectancy rates at birth have been steadily increasing for decades. Overall, the rates have risen from 66.5 in 2000 to 72.0 in 2016, the most recent year for which data is available.
African countries have experienced the greatest increase in that time period, gaining 10.4 years (50.8 to 61.2), compared with the Eastern Mediterranean region which saw the least amount of growth, at just 3.6 years (65.5 to 69.1). In China, life expectancy as of 2015 is 76.2, up from 72.1 in 2000, placing it among the top third of countries across the globe.
In many markets, increases in life expectancy are compounded by declines in younger population segments. Japan, for example, is experiencing an all-time low in birth rates. The U.S. and Germany have births per female of 1.88 and 1.50, respectively, while China sits at 1.57. This combination has left some countries lacking a sufficient pool of young people to enter the workforce and contribute to pension programs. By 2050, China will have just 1.3 workers for each retiree compared with the current 2.8.
Although these trajectories might seem irreversible, the experiences of the U.S. and U.K. demonstrate how quickly things can change. The U.S. Centers for Disease Control and Prevention found that the U.S. has experienced a slight decline in life expectancy over the past couple years, decreasing from 78.9 in 2014 to 78.6 in 2016. Some observers, including those at the National Center for Health Statistics, blame opioid-related drug overdose deaths for the recent decline.
In fact, “unintentional injuries,” which include drug-related deaths, are among the top three causes of death and have increased from 40.5 deaths per 100,000 people in 2014 to 47.4 in 2016 – an unprecedented leap. Chronic conditions, such as heart disease and diabetes, also remain top causes of death in the country.
Meanwhile, research out of the U.K. shows a similar drop over the past several years. Still, it’s much too early to tell what the long-term implications are and whether other countries might face a similar deceleration in life expectancy.
THE EFFECTS OF LONGER LIFE SPANS ON RETIREMENT AND PENSIONS
Demographic patterns are also exerting pressure on governments to spend more on pensions or alter benefits. In Canada, where life expectancy is at a high of 82.2 as of 2015, the retirement age is expected to hold steady at 65. In the Netherlands, where life expectancy stands at 81.9 years (up 2.5 years from a decade ago), the retirement age is expected to increase from age 66 to 67 by 2022.
In Brazil, where the life expectancy is 75, the retirement age has been 55 for decades. Retirees can expect 70 percent of their final salary for the rest of their lives, a figure that accounts for about one-third of all government spending in the country. But with many observers partially blaming this generous system for the country’s economic struggles, Brazil is expected to make a change to increase its minimum retirement age – perhaps by as much as a decade.
The fluctuations and uncertainty in life expectancy are disrupting the forecasts on pension schemes. For example, every year of increased life expectancy could increase pension plan liabilities by three to four percent. Therefore, understanding longevity expectations from year to year is important, as these forecasts enable organizations to accurately project the full extent of their liabilities and make informed decisions about financing.
RESPONDING TO LONGEVITY RISKS
Public pension plans represent a significant portion of government spending – upward of 15 percent in some countries. These programs have traditionally been structured as a defined benefit (where employees are guaranteed a certain level of income each year after retirement) rather than a defined contribution, such as a 401(k) plan, where employees determine the amount they pay into a retirement fund.
As demographics and life expectancy have shifted, public pension spending has represented a larger percentage of GDP.
Traditional plans make up the vast majority of public pension plans. In the U.S., for example, 84 percent of local governments still offer such plans. This structure has been a contributing factor to the growing pension costs for many countries. For example, Brazil’s annual pension burden is approximately $210 billion, equal to 12 percent of its GDP. After the current administration began moves to increase the retirement age, public outcry caused it to back down, likely leaving the issue for the next administration.
By contrast, private sector organizations have gradually transitioned to defined-contribution programs, particularly as employees are less likely to spend their whole career at one company. Just four percent of U.S. private sector organizations still offer defined-benefit pension plans, a significant drop from 60 percent 35 years ago. Approximately 14 percent of companies offer a mix of both types of plans. Higher-than-expected pension costs and lower investment returns due to market volatility have inspired some firms to divest themselves of their pension liabilities altogether, offering enrollees one-time, lump-sum payouts. Other organizations are transitioning their liabilities to an insurer with an insured annuity buyout and exploring how to service remaining pension liabilities.
Feinsod further explains that the transition from defined benefit to defined contribution plans has shifted the retirement “burden.” “We’re seeing that people who need to make their savings last longer are also facing increased health care costs.”
PENSIONS ARE NOT THE ONLY WORRY: ADDRESSING HEALTH CARE CONCERNS
While unfunded pension liabilities have produced dire headlines and sparked contentious debates about the expectations for the public and private sectors, increased longevity also has serious repercussions for health care spending.
Rob Reiskytl, partner and actuarial retirement consultant, Aon, explains, “If we look at the U.S., trends show that benefit spend on retirement is decreasing while at the same time, health care spend is on the rise.” Studies show, for example, U.S. employees are expected to need, on average, 11 times their final pay for retirement at age 65 with at least one-quarter of those funds expected to be needed to cover health care costs. As employers are spending less on retirement, Reiskytl further underscores the responsibility now facing the individual: “employees are being asked to make up the shortfall.”
Dialogue has focused on the overall cost of health programs, the rise of chronic conditions around the globe, and initiatives to raise awareness and give individuals the tools to pursue health and wellbeing. Feinsod reinforces the connection: “Wellbeing isn’t isolated to a single area; it’s an overall state of balance that consists of having the appropriate resources – including financial resources – to achieve optimal health.” In a few short years, 75 percent of multinationals expect to have a global wellbeing strategy, up from just 34 percent today.
As the connection between health and wealth becomes more pronounced, companies are focused on helping employees with all aspects of their wellbeing – likely with an increased focus on financial wellbeing, inclusive of both retirement savings for tomorrow and investments in personal health today.