The International Monetary Fund is worried about longevity shock, with potentially lethal consequences for smaller UK annuity providers and big problems for the Government.
It is not just the shock we all know about – when millions of middle-class Britons realise how poor they will be in retirement – but the one we don’t know about, that even the predictions of pensioner penury may be a massive underestimation.
The IMF’s April report, The Financial Impact of Longevity Risk, describes a pension time-bomb gone nuclear, warning that the demographic problems already identified may be the tip of the iceberg. It says future medical cures or other unforeseen increases in life expectancy could leave actuaries playing catch-up and global finances on the brink of Armageddon.
It fears a further under-estimation of longevity by three years could increase costs of ageing by around 50 per cent of GDP by 2050, spelling trouble for employers, pension schemes, insurers and governments.
Aside from the old people left in poverty, it is governments that have most to lose from a longevity shock on the scale warned by the IMF. Whether through state and public sector pension liabilities, the provision of services for the elderly or the de facto guarantees behind compensation schemes behind private sector products and pensions, the Government will pick up most of the tab if we all live too long. For the UK, the IMF predicts a three-year under-estimate on longevity increases would mean an increase in public debt from 76 per cent of GDP to 135 per cent.
The IMF saves its sternest warnings for specialist annuity providers in Britain. Diversified insurers will gain on their life book if longevity predictions underestimate lifespans but offsetting losses on their annuity books, the specialists have no such back-up. It says: “Without the benefits of diversified business lines, standalone annuity providers run even greater risks of insolvency.”
The IMF predicts the interconnectedness of insurance companies with banks and other financial institutions means the economic consequences of a longevity shock could propagate through the entire financial system.
Partnership says the UK life industry has already factored in the risk of not having quantified all the longevity risk. It says most of the longevity increases in the UK have been achieved by preventative treatments and lifestyle changes, rather than cures for people with existing conditions. This, it says, makes its clients less likely to benefit from longevity rises. And, it says, it is already required to model factors such as a cure for cancer.
Partnership may be right but, in other areas, experts may get it wrong. In 1977, the predicted life expectancy of someone born in 2010 was 71 years. By 2000, that had increased to 77.
The IMF is looking at a worst-case scenario and its blackest statistics for calculations are based on a retirement age of 65, something the Government has already moved to address and most people under 35 no longer expect anyway.
But it would be wrong to brush the report aside. These drivers, central to Solvency II, should lead to a broader debate about risk-sharing. As solvency requirements rise and long-term investment returns fall, insurance company share-holders will be increasingly disenchanted with products giving 100 per cent guarantees.
Just last week, Allianz Global Investors CEO Elizabeth Corley warned it would be stupid to think the range of guaranteed products available today will still be here in the future. Longevity risk is unavoidable and the sooner we work towards products that can accommodate it the better.
John Greenwood is editor of Corporate Adviser Money Marketing