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Span’s labyrinth

Increasing life expectancy will have an impact on many areas of financial services

The Actuarial Profession says life expectancy is increasing at a rapid rate and that estimates of how long people are likely to live in retirement have not kept up with this rate of change.

A one-year increase in life expectancy could theoretically increase the total UK private-sector pension bill by as much as £30bn to £40bn. It could also force life insurers to add as much as £3bn to £4bn to their reserves. This would wipe out any gains in pension scheme solvency that had come about through rising investment returns.

Following discussions with The Actuarial Profession, the FSA and The Pensions Regulator, the Board For Actuarial Standards has launched a review of the assumptions about mortality made in actuarial calculations. The review will be wide ranging and will address current mortality rates and other risk factors but will initially concentrate on future rates of mortality improvement. It expects to issue a discussion paper in early 2008, followed by an exposure draft, which may lead to new standards being introduced.

The Actuarial Profession has also published a draft library of mortality projections designed to improve access to information on mortality and enable a consistent approach in projection disclosures.

The Continuous Mortality Investigation library of mortality projections contains 42 different projections of mortality, each in an identical format. Each projection contains one possible scenario for mortality rates at each age through to the year 2010. The library is accompanied by CMI working paper 27 which explains how each of the projections has been derived and how the projections may be used.

The Actuarial Profession has also written to those actuaries with certificates that allow them to hold specific roles in relation to pension schemes and life insurance companies. In the letter, it indicates that “all relevant recent experience confirms that mortality rates for the retired population in the UK have continued to fall rapidly, with no real signs of slowing, as demonstrated in the Recent Trends in Mortality section of the working paper. Some projections which have been in common use may no longer be considered reasonable assumptions, even if they have been included within the library.”

It goes on to say: “The extent to which the pace of improvements in mortality might be sustained in future is a matter on which there is, rightly, a range of views, both within The Actuarial Profession and in the wider community of demographers and other experts. We encourage all actuaries to compare recent experience with the future rates of improvement within any projections they are considering recommending.”

I am grateful to John Page, our head of pensions research and consultancy, for this summary. His view is that it is essential that any assumptions made regarding mortality are realistic, as otherwise an inappropriate (too low) allowance for pensioner longevity could result in the need for significant increases in the required funding levels for defined-benefit schemes in future.

This is highlighted by research by BDO Stoy Hayward Investment Management which found “marked discrepancies” in the longevity assumptions used to calculate deficits for employers participating in local government pension schemes. Some schemes had retained the same longevity assumptions used in 2004.

Although BDO Stoy Hayward indicated that geographic and socio-economic differences will mean that the longevity assumptions will differ from scheme to scheme, it felt that based on its understanding of changes in mortality since 2004, a further 4 to 5 per cent should be added to total liabilities, which for local government pension schemes as a whole equates to around £5bn.

Increased longevity has a significant impact on all other areas of financial planning. Just as the cost of providing an income in retirement is likely to rise, the cost of providing protection may fall. Any help to increase the likelihood of providing what for many families is much needed financial protection will be welcome.

Inheritance tax is another issue that will be affected. A longer life will mean greater expenditure and possibly the need to provide for care fees. This could lead to inherited estates being reduced. The appeal of equity release will almost certainly increase.

Longer lifespans may well cause those who could have an IHT liability to be even more cautious about making lifetime gifts from which they can no longer benefit. Arrangements under which they can continue to access capital or draw regular payments will have appeal. There must be appropriate investments underneath these trust-based arrangements, possibly with appropriate levels of guarantee or allocation and management to minimise risk.

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