In the second part of our investigation into longevity risk, Sara Benwell explores the impact on defined contribution schemes
Will we all live to a thousand or is the trend of rising longevity about to come to a crashing halt? It all depends on who you speak to.
On the one hand, renowned scientist Dr Aubrey De Grey has famously predicted that the first person who will live to 1,000 has already been born, while the International Longevity Centre predicts that the age of death for retirees will cluster in the early 90s.
There are two diametrically opposed philosophies at play here, one which supposes that medical advancements will continue to prolong life indefinitely, and the other which accepts that there is an ultimate limit to life, a point at which cells can no longer reproduce effectively and human life must come to an end.
One thing is clear, longevity estimates have been rising steadily for the last 70 years. When the state pension was introduced in 1948, a person who retired at 65 was only expected to live another two years. Now people are living more than 20 years post-retirement.
In fact, ONS predictions say that of the women currently aged 60, about 54,000 of those people might live to be 100. Of the girls currently aged 10, they predict 116,000 will live to 100. Essentially the number of people living to 100 is expected to double over the next 50 years.
While most people aspire to living longer, increasing life expectancies are causing additional financial pressure for defined benefit schemes, particularly those going down a derisking journey.
Of course, longevity is not just affecting the DB world. Since 6 April, people have much more control over their pensions. This can introduce new risks.
Richard Willetts, director of longevity at annuity provider Partnership, explains. “The longevity risk for an individual is far more difficult to manage than for a pension scheme because an individual might live one year or they might live 40 and it’s impossible to know for what sort of duration you’re managing your fund.”
Another problem is that people tend to underestimate their own longevity. In fact, Partnership research shows that people tend to do so by as much as five to ten years. “For someone who is coming up to retirement age, it’s much more likely that they’re going to survive for 30 years rather than 15-29 years, so it’s a really significant difference,” says Willetts.
Even more alarming is that people don’t really understand average longevity. “That’s the risk in a DC scheme,” Hugh Nolan, chief actuary at JLT Employee Benefits, explains, “not that people don’t get the basic idea of ‘I’m going to live for 20 years’, they just don’t get the random variation. It could be five, it could be 35. And how as an individual do you deal with that in terms of planning your retirement income?”
Unfortunately, the downside of the abolition of compulsory annuitisation is that products like drawdown require people to manage their own longevity risk.
It doesn’t help, says Jon Palin, an associate at consultancy Barnett Waddingham, that longevity trends themselves can have a knock-on effect on the popularity of annuities. “If people underestimate their life expectancy, it makes annuity rates look particularly bad and that might make people decide to manage their own money.”
One solution, argues Willetts, is better education. “Certainly better communication of the value of annuities is obviously going to be much more important given the new flexibilities people have now.”
On the other hand, Nolan thinks the future is in products that will help people manage their own longevity individually. ”Watch in the market for new and exciting products that are going to come out and give people a chance to protect themselves against longevity individually, without having to buy annuities in the old traditional constrained investments form, that I think could be a really good step forward in the market.”
One thing is clear, creating innovative and affordable ways to take longevity risk off the table, either for members or schemes, could help DC trustees to deal with this new issue.