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Life expectancy and pensions: High-class problem or calamity of so long life?

Life expectancy and pensions: High-class problem or calamity of so long life?. Edward Whitehouse Head of Pension Policy Analysis OECD. Motivation.

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Life expectancy and pensions: High-class problem or calamity of so long life?

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  1. Life expectancy and pensions:High-class problem or calamity of so long life? Edward Whitehouse Head of Pension Policy Analysis OECD

  2. 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)

  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 DB+adjustments 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 Mexico Canada 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 shouldn’t 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

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