Source: www.inese.es

Governments must acknowledge that they are exposed to the risk of longevity, adopt methods for better sharing this risk with the organizers of the private sector pension plans and private individuals, promote the growth of markets for the transfer of the longevity risk and disseminate more information on longevity and financial preparation for retirement. These are the four recommendations made by the International Monetary Fund (IMF) in its latest Global Financial Stability Report (see here).

In this analysis, the document (see here) highlights the fact that as populations get older in coming decades they will consume a greater percentage of resources, bringing pressure to bear on public and private balances. “The governments and private sector agencies that offer pensions have been preparing for the financial consequences of ageing. Nonetheless, these preparations are based on basic demographic projections that in the past have constantly underestimated how long people will live,” said the IMF.

The IMF also pointed out that there are very few governments and agencies that offer pensions that duly recognize the risk of longevity. Hence, the report concludes that if today’s average life expectancy were to increase by three years by 2050 – an assumption that is in line with previous sub-estimation rates, the costs of ageing, which are already considerable, could increase by 50%. Illustrated with an example, the report shows that in the case of private pension plans in the United States, this increase in longevity could increase pension liabilities by about 9%. “As total pension liabilities are considerable, the companies that run pension plans will have to multiply their normal annual contributions several times, in general terms, in order to be able to assume these additional liabilities,” it says.

ACT TO DEAL WITH THE LONGEVITY RISK

According to the IMF, action must be taken on several fronts to reduce the aforementioned longevity risk. First of all, governments must recognize that defined benefit (DB) plans expose their own employees and elderly people in the social security systems to considerable longevity risks. Secondly, the risk must be duly distributed among private individuals, the agencies that run the pension plans and the government. Thirdly, one can recur to the capital markets for transferring the longevity risk of the pension plans to those who are most capable of managing it.

The report concludes that an essential reform would be to allow the retirement age to increase in proportion to life expectancy. This may be a mandatory measure imposed by governments, but one could also offer incentives to individuals to postpone retirement, stresses the IMF. Finally, better recognition and mitigation of the longevity risk is a process that must begin now. If these measures are postponed, the agency argues, they will take years to come to fruition and it will be even more difficult to properly address this matter.

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