ARTICLES OF INTEREST

Increasing lifespans: A Pension Plan’s True Longevity Risk

by Richard Brown, Longevity Consultant, and Ian Edelist, CEO of Club Vita Canada

Earlier this year, The Lancet (http://www.thelancet.com/journals/lancet/article/PIIS0140-6736(16)32381-9/abstract) made headlines by publishing a study predicting women in South Korea will be the first, on average, to live to age 90. The study used statistical methods to predict the life expectancies of people in different countries who will be born in 2030.

Canadian women born in 2030 will live to age 87, on average – ranking 10th out of 35 for longevity in industrialized countries. U.K. women rank 21st, and U.S. women rank 27th. Canadian men born in 2030 are closer to the top of the charts and are expected to live to age 84 – ranking 4th in the industrialized world – while U.K. men rank 14th, and U.S. men rank 26th.

Increasing longevity is good news for the global population – but it’s a significant risk for pension plan sponsors, since how long people will live after retirement is a key determinant of a plan’s cost.

How fast are lifespans increasing?

Between 1970 and 2010, the life expectancy for Canadian males who retired at age 65 increased by five years, and female retiree lifespans increased by just over four years. But the assumptions Canadian actuaries use to value pension plans assume the rate of increase in Canadian longevity will slow considerably in the near future.

For example, the life expectancy of a male pensioner at age 65 is expected to increase by 0.9 years over the next decade. However, the corresponding increase in lifespan for Canadian males between 2000 and 2010 was two years. The U.K. and U.S. assumptions also assume a slowdown, but it’s not nearly as dramatic.

The following two graphs show the life expectancies used by actuaries in each of Canada, the U.K. and U.S., and how they are expected to change over time.




Notes: The charts above show period life expectancy by calendar year incorporating mortality improvements based on the following mortality assumptions: Canada – CPM Combined base mortality with CPM-B mortality improvement scale. US – RP2014 Healthy Annuitant base mortality with MP-2014 mortality improvement scale. UK – S2PA base mortality with CMI2014 mortality improvement scale with a 1.5% ultimate improvement rate.

The results are quite striking.  Although Canadian retirees are currently living longer than their counterparts in the U.S. and U.K., Canadian pension plans are implicitly assuming that this will only be the case for another decade or two. American retirees are expected to live longer than Canadian retirees by 2050.  And by 2070, U.K. retirees will live 2 to 2 ½  years longer than Canadian retirees. 

One size doesn’t fit all

Just as these three countries will experience different rates of life expectancy improvement for their respective populations, different Canadian pension plans will also experience different rates. But in Canada, only one set of longevity improvement assumptions is commonly used. Having just one view on future longevity improvements differs from the U.K. environment, in which actuaries can choose a set of longevity improvement rates that makes sense for each plan from within a broader framework.

What if we miss the mark, and lifespans in Canada increase faster? For example, the rate at which U.K. retiree lifespans are assumed to increase is almost double what Canadian actuaries assume. Canadian insurers that take on pensioner longevity risk (e.g., via group annuities) look at this very carefully. Not only do they tend to use different assumptions than Canadian pension actuaries, but they also need to put aside additional capital to mitigate the risk of pensioners living even longer than expected. 

And of course, misestimating longevity can have a significant impact on a plan’s liabilities. For example, if Canadian retirees’ longevity improves as expected for U.K. retirees, the liabilities of a $1-billion pension plan would increase by about $50 million, or 5%.  Canadian insurers would need to test whether those rates would increase faster than expected, and they would need ensure they are able to withstand a further $70 million increase in liabilities, for a total $120 million increase in liabilities, or 12%, from the current Canadian pension longevity improvement assumption.

Dealing with longevity risk

It is the increase in liabilities due the uncertainty of how much our lifespans will increase that pension plan managers, pension committees and boards of trustees need to consider when deciding on whether to transfer longevity risk to insurance companies. Can they afford the increased contributions that would come from a 12% increase in liabilities?

Longevity improvements are the next frontier in research for Canadian pension plans.  A good first step for pension plan sponsors in managing longevity risk is to determine what the potential risk of misestimating longevity improvements means to them. Then they can talk to their actuaries about whether their plan’s longevity improvement assumptions should be the same as for other plans in Canada, or whether they need to be adjusted based on the underlying membership. It’s time to start the conversation.

 



    Richard Brown FCIA FSA CFA

    Longevity Consultant
    Club Vita Canada




Richard Brown is a longevity risk consultant with Club Vita Canada Inc., a wholly owned subsidiary of Eckler Ltd. Richard provides longevity analytics services to the Canadian pension industry and oversees Club Vita Canada’s longevity modelling and research efforts. Richard has more than 10 years of experience providing risk management consulting to pension plan sponsors. He is a fellow of the Canadian Institute of Actuaries and the Society of Actuaries, and is a CFA® charterholder.
 



    Ian Edelist, FCIA FSA
    Chief Executive Officer
    Club Vita Canada





Ian Edelist is CEO of Club Vita Canada, responsible for leading its strategic direction and guiding its vision to be the driving force behind the mainstream adoption of advanced longevity analytics in Canada. Ian is also a Principal with Eckler Ltd., and leader of Eckler’s public sector practice in Toronto. He has a deep understanding of how longevity affects plan sustainability and benefit security, and the need for better longevity data and risk management tools.