Life expectancy is increasing. While this is good news for us as individuals, longevity will place a heavy burden on the state ? and the state is not prepared, warns the Internationa
Life expectancy is increasing. While this is good news for us as individuals, longevity will place a heavy burden on the state ? and the state is not prepared, warns the International Monetary Fund.
In its latest Global Financial Stability Report, the IMF advises that longevity risk is large and affects all of society, but few governments adequately recognise it. Western governments are underestimating future life expectancy and rapidly ageing populations will place a heavier burden on taxpayers.
The April 2012 report states:
?Unexpected longevity, while clearly beneficial for individuals and society as a whole, is a financial risk for governments and defined-benefit pension providers, who will have to pay out more in social security benefits and pensions than expected. It may also be a financial risk to individuals, who could run out of retirement resources themselves.?
If not addressed soon, these risks will build over time and could have large negative effects on private and public sector balance sheets, already weakened after the financial crisis.
Analysts found that both governments and the financial sector have routinely underestimated rising life spans by three years.
If citizens live just three years longer than expected, the already large costs of ageing would increase by another 50% by 2050. On a global scale, this amounts to tens of trillions of US Dollars.
The IMF report suggests three main options for tackling the problem: higher annual contributions; reduced payouts and higher retirement ages – it is essential that the state pension age is automatically linked to life expectancy. It advocated greater risk sharing between government, individuals and pension schemes.
Although measures would be unpopular with voters, the IMF said that the longer longevity risk is ignored, the harder it is to resolve, so governments need to take action now.
The UK
The IMF warned that the UK?s ageing population could trigger a ?750bn pensions time bomb if longevity increases slightly quicker than expected.
The national debt would possibly increase from 76% of GDP to 135%. The additional ?750bn cost would be a combination of state pension and public sector pensions (whose liabilities are already ?1.3 trillion) plus the cost of rescuing private sector schemes which fail because they underestimated the impact of longevity.
The IMF assumes the whole cost will fall on its taxpayers.
According to the UK?s Office for National Statistics, life expectancy for boys born in 2010 is 78.22 years, while for girls it is 82.3 years. Around one in three children born this year will live to be 100.
IMF analysts however believe the UK projections of life expectancy are ?constantly too low in each successive forecast, and errors are generally large?.
UK pension funds estimate the average life expectancy for a 65 year old male is 86.2. This is higher than the official life expectancy of 82.2, but the IMF analysis implies that it should be 89.2 years.
The number of over-65 year olds in the UK is expected to increase from 10 million in 2007 to 16 million in 2032. Within 20 years, a quarter of the population will be over 65.
The IMF forecasts only cover the direct cost of maintaining pension incomes at current levels for an ageing population and not the associated costs like health and social care. The Office for Budget Responsibility has already warned that the costs of age-related care threaten to make public finances unsustainable – before the risk of increasing longevity.
Europe
An editorial published in Bloomberg Business Week in January this year highlighted longevity concerns for Europe as a whole.
A study commissioned by the European Central Bank in 2009 found that state funded pension obligations in 19 EU countries were about five times higher than their combined gross debt.
The countries covered had almost ?30 trillion of projected obligations for their existing populations. Germany accounted for ?7.6 trillion and France ?6.7 trillion of the liabilities, with state obligations three times the size of their economies. According to The Economist, the ratio of people of working age for every retired person in France will drop from 4.2 in 2011 to 1.9 by 2050.
This is described as a ?totally unsustainable situation?. The problem has only been made worse by the economic downturn. Stable or falling birth rates, combined with rising life expectancy, are adding to the pressures.
Europe has the highest proportion of people aged over 60 in any region of the world. The United Nations forecast that it will rise from 22% in 2009 to almost 35% by 2050.
We could all be affected by action taken by governments to tackle longevity risk. Taxes and/or social security contributions could be increased to cover the escalating costs. Pension payouts may be smaller in future, and we may have to contribute more towards heath care and retirement homes.
On a personal level, your retirement savings could well need to last for longer than envisaged. Inflation becomes a bigger threat to your financial security the more years you spend in retirement, particularly if you have to cover more costs than expected.
Retired people should take advice to shelter their wealth from tax as much as possible and structure it with the aim of keeping pace with inflation.
A professional firm like Blevins Franks would advise on a strategy to preserve your wealth which is based on your personal circumstances and objectives.
By Bill Blevins, Blevins Franks Financial Correspondent
23rd April 2012
