Life expectancy and pensions: Highclass problem or calamity of so long life

1
Life expectancy and pensionsHigh-class problem
or calamity of so long life?

• Edward Whitehouse
• Head of Pension Policy Analysis
• OECD

2
Motivation

• Ive often said that this is a high-class
  problem. Its the result of something wonderful
  the fact that we are living a lot longer.(Bill
  Clinton, President of the United States, 1999)
• What dreams may come when we have shuffled off
  this mortal coil must give us pause theres the
  respect that makes calamity of so long life.
  (Hamlet, Act 3, scene 1)

3
Definitions

• Longevity risk
• Without annuities, people might outlive
  retirement capital, because how long individuals
  live is uncertain
• Life-expectancy risk
• The average length of life of a cohort is
  uncertain
• During retirement, this risk is borne by the
  pension/annuity provider
• Focus here is on life-expectancy changes in the
  period between paying pension contributions and
  drawing benefits

4
Who bears life-expectancy risk?

• DB and points schemes
• Life-expectancy risk borne by pension providers
• Government or employers
• But ultimately, by taxpayers or shareholders
• DC and notional-accounts schemes
• Pre-retirement life-expectancy risk borne by
  individual retirees through annuity calculation

5
How large is life-expectancy risk?
6
Modelling mortality

• Use extrapolative (rather than biological)
  methods
• Pioneered by Lee and Carter
• Three stages in the process
• Data on past changes over time in mortality by
  age
• Distribution of past changes in mortality by age
• Simulation of future mortality changes based on
  the data

7
Changing mortality rates
Men aged 50-54, G7 countries, 1945-2002, relative
to Japan in 2002 Source Human mortality database
8
Mortality-improvement distribution
100
75
Percentiles of distribution
50
25
0
-
20
-
15
-
10
-
5
0
5
10
Mortality improvement for men aged 60-64 over
five-year periods, G7 countries, 1945-2002
9
Life-expectancy uncertainty
Note OECD average. Source Baseline mortality
rates from UN/World Bank database, projections by
OECD
10
Who bears life-expectancy risk?
11
Allocating life-expectancy risk

• Use standard measures of pension entitlements
• Average pension level and average pension wealth
  (relative to average not individual earnings)
• With a pure DB pension system
• Pension level constant with changing life
  expectancy
• Pension wealth higher for higher life expectancy
• With a pure DC pension system
• Pension level falls with higher life expectancy
• Pension wealth constant with changing life
  expectancy

12
Structure of pension systems

• Schemes where entitlements change with life
  expectancy
• DC
• Notional accounts
• DB with adjustments
• Schemes where entitlements constant with life
  expectancy
• Schemes where entitlements offset effect of
  life-expectancy changes on other parts of the
  system

13
Impact of recent pension reforms
14
Structure of pension systems
Italy
DC
Poland
Notional acs
Germany
DBadjustments
Finland
No link to life expectancy
Portugal
Mexico
Offsets link to life expectancy
Denmark
Sweden
France
Australia
Slovak Republic
Hungary
Norway
Canada
Japan
United Kingdom
United States
0
25
50
75
100
15
Average pension level
Denmark
Hungary
75
75
Italy
Sweden
Finland
Slovak Republic
Norway
Poland
Canada
Mexico
50
50
Australia
France
United States
Portugal
Japan
United Kingdom
25
25
0
0
High
Median
Low
High
Median
Low
Weighted average pension, per cent of
economy-wide average earnings under three
scenarios for future life expectancy
16
Average pension wealth
12.5
12.5
Hungary
Denmark
Sweden
Norway
Italy
10
10
Finland
Portugal
Slovak Republic
France
Poland
7.5
7.5
Canada
Australia
United States
Japan
5
5
Mexico
United Kingdom
2.5
2.5
0
0
High
Median
Low
High
Median
Low
Weighted average pension wealth, multiple of
economy-wide average earnings under three
scenarios for future life expectancy
17
Life-expectancy risk on individuals
Poland
Portugal
Finland
Italy
Sweden
Mexico
Slovak Republic
Denmark
Germany
Hungary
Australia
Norway
France

Canada
Japan
Life
expectancy risk
-
United Kingdom
borne by individual retirees
per cent of total
United States
0
25
50
75
100
18
Conclusions and policy implications
19
Pension reforms and their motivation

• What did countries do?
• 12 out of 18 OECD countries that had major
  pension reforms in the last 15 years have
  introduced some link to life expectancy
• 8 with DC, 3 notional accounts, 3 link DB pension
  levels to life expectancy, 2 link DB qualifying
  conditions
• What were the motives?
• Privatisation
• Justify benefit cuts
• Other parametric changes (early retirement etc.)

20
Sharing life-expectancy risk

• Who now bears life expectancy risk?
• Individual retirees bear just 10 in Norway and
  30 in Australia
• In Poland and Portugal this is 100 or more
• No systematic relationship between type of
  life-expectancy link and allocation of risk
• How should life-expectancy risk be shared?
• Living longer is a good thing, so difficult to
  see why beneficiaries shouldnt bear some of
  the associated cost

21
Future developments

• Which countries next?
• 17 OECD countries do not have a life-expectancy
  link in mandatory pension system
• Case for life-expectancy links is strongest in
  countries with large mandatory pensions, e.g.
  Austria, Greece, Luxembourg and Spain with high
  public pensions