What will be the effect on pension schemes from a reduction in life expectancy growth?
Five years ago Brexit sounded like something you’d put in Room 101, Leicester City were in mid-table obscurity in the second tier of English football and life expectancy projections were set to continue their upward trajectory. A lot has changed since then, some changes only the bravest would have predicted.
Focussing on longevity, the perception was we’re all living longer than ever and life expectancy would continue to rise in future. However, in March the actuarial profession published its latest set of mortality projections confirming a slow-down. In fact, life expectancy today is now broadly the same as it was 5 years ago.
So why has life expectancy stopped increasing?
Some observers have suggested cold winters, unusual strains of the flu and a decline in healthcare spending as causing ‘blips’ in mortality rates, but five years is more than a blip. We must therefore accept these low levels may be due to longer term influences.
So what does this mean for pension schemes? Well, private sector pension schemes are currently setting aside around £250bn (Source: KPMG analysis) to cover the cost of future increases in life expectancy – that’s double the annual budget of the NHS in England. If observations over the last five years continue, could this money flow back into pension schemes and help plug deficits?
That may be optimistic. Even the most ‘doomsday’ of demographers would accept that life expectancy will still increase to some extent. Most long term longevity projections already allow for improvements to slow down over the next few decades. However, if this slowdown is brought forward, we may see deficits start to fall further.
Two other important reports were published in March 2017 reviewing the State Pension Age (or “SPA”), one from the Government Actuaries Department and, the other, John Cridland CBE’s independent review on behalf of the former Pensions minister Ros Altmann. Both reports suggested an acceleration of the increases to the SPA were needed, which many people would see as their state pension retreating into the distance.
The principles underlying the Government’s SPA review in 2013, were that it should be linked to longevity and people should on average spend up to a third of their adult life in retirement. To some extent, the suggested changes to the SPA are playing ‘catch-up’ to meet these objectives. However, their analysis and recommendations are also based on population projections which are a few years of out date and therefore may not fully reflect recent experience. The Government is due to respond to the recommendations shortly, so we are eagerly awaiting their response.
One final observation I would like to draw from the Cridland report is the wide variations in life expectancy amongst the population. For example, life expectancy from age 65 is around 4-5 years lower in the most deprived areas compared to the more affluent areas for both men and women.
Traditional methods use post-codes to adjust for variations in longevity in a pension scheme’s mortality assumption. These generally assume the more affluent an area, the higher the life expectancy. This may be true on ‘average’, but we now have more sophisticated tools at our disposal - using information gathered on an individual’s actual health status. Knowing whether someone is in good or poor health can give a better understanding of their potential life expectancy than just relying on post-code or a person’s income.
Using better data can actually lead to better outcomes for pension schemes too. From KPMG’s experience, medically underwritten mortality studies (or ‘MUMS’) can often lead to a reduction in liabilities compared to the assumptions typically used based on traditional prudent methods.