life expectancy and pensions: high-class problem or calamity of so long life?
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Life expectancy and pensions: High-class problem or calamity of so long life?. Edward Whitehouse Head of Pension Policy Analysis OECD. Motivation. - PowerPoint PPT PresentationTRANSCRIPT
Life expectancy and pensions:High-class problem or calamity of so long life?
Edward WhitehouseHead of Pension Policy Analysis
OECD
Motivation
• “I’ve often said that this is a high-class problem. It’s 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: there’s the respect that makes calamity of so long life.” (Hamlet, Act 3, scene 1)
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
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
How large is life-expectancy risk?
Modelling mortality
• Use extrapolative (rather than biological) methods– Pioneered by Lee and Carter
• Three stages in the process1.Data on past changes over time in mortality by age2.Distribution of past changes in mortality by age 3.Simulation of future mortality changes based on the
data
Changing mortality rates
0
50
100
150
200
250
1945-1949 1950-1954 1955-1959 1960-1964 1965-1969 1970-1974 1975-1979 1980-1984 1985-1989 1990-1994 1995-1999 2000-2002
Men aged 50-54, G7 countries, 1945-2002, relative to Japan in 2002Source: Human mortality database
Mortality-improvement distribution
Mortality improvement for men aged 60-64 over five-year periods,G7 countries, 1945-2002
0
25
50
75
100
-20 -15 -10 -5 0 5 10
Percentiles of distribution
Life-expectancy uncertainty
Baseline 5% 25% Median 75% 95% Life expectancy (years) Men 15.1 20.1 19.1 18.5 18.0 17.1 Women 18.7 23.7 22.8 22.2 21.7 20.9 Change (years) Men 0.0 +5.0 +4.0 +3.4 +2.9 +2.0 Women 0.0 +5.0 +4.1 +3.5 +3.0 +2.2
Note: OECD average. Source: Baseline mortality rates from UN/World Bank database, projections by OECD
Who bears life-expectancy risk?
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
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
Impact of recent pension reforms Defined
contribution Notional accounts
Benefit levels
Qualifying conditions
Australia Canada Denmark Finland France Germany Hungary Italy Japan Mexico Norway Poland Portugal Slovak Republic Sweden United Kingdom United States
Structure of pension systems
0 25 50 75 100
United States
United Kingdom
Japan
Canada
Norway
Hungary
Slovak Republic
Australia
France
Sweden
Denmark
Mexico
Portugal
Finland
Germany
Poland
Italy
Offsets link to life expectancy
No link to life expectancy
DC
Notional acs
DB+adjustments
Average pension level
0
25
50
75
High Median Low
FranceUnited States
United Kingdom
Japan
Canada
Norway
Australia
Hungary
0
25
50
75Denmark
Sweden
Slovak Republic
Italy
Mexico
Finland
Portugal
Poland
High Median Low
Weighted average pension, per cent of economy-wide average earningsunder three scenarios for future life expectancy
Average pension wealth
0
2.5
5
7.5
10
12.5
France
Australia
Japan
Hungary
Canada
United Kingdom
United States
Norway
High Median Low0
2.5
5
7.5
10
12.5
PolandPortugal
Finland Italy
Mexico
Sweden
Slovak Republic
Denmark
High Median Low
Weighted average pension wealth, multiple of economy-wide average earningsunder three scenarios for future life expectancy
Poland
United States
Life-expectancy risk on individuals
0 25 50 75 100
United Kingdom
Japan
Canada
France
Norway
Australia
Hungary
Germany
Denmark
Slovak Republic
Mexico
Sweden
Italy
Finland
Portugal
*
Life -expectancy riskborne by individual retireesper cent of total
Conclusions and policy implications
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.)
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 shouldn’t bear some of the associated cost
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