The future of understanding and predicting longevity
The future is highly uncertain, but a key benefit of predictive approaches is that they can increase confidence in the pricing and funding of future retirement income solutions. However, holding longevity risk continues to be a major challenge for pension funds, insurers and governments and better methods need to be developed to share the risk appropriately.
A disease-centred mortality model, based on forward-looking scenarios, can play a key role in the evaluation of longevity risk and building blocks are essential for the model’s development.
It is clear that scenario development would need to be a continuous and long-term project. It would be advantageous for the various interested parties to act in collaboration, perhaps through a forum with a specific mandate to develop key areas of research. Forward-thinking predictions for mortality would also further develop the capital market for longevity risks, which is needed to create additional capacity to transfer financial risks associated with longevity. The creation of a liquid market would require many developments, such as improved investor education, accounting standards and access to more consistent and granular data. Forward-looking mortality models could be helpful in setting a price for trades to take place.
Recommendations for pension plan stakeholders
Employers and pension plan managers who currently provide a guaranteed retirement income for their employees need to examine their options carefully. They should appreciate the risk of under-reserving against member longevity and should consider ways to mitigate against future, increased liabilities. However much analysis is undertaken, considerable financial uncertainty will always remain. Employers and pension plan managers need to assess their potential longevity exposure and decide whether it is best to retain it or pass some, or all, of it onto a third party that may be better placed to take on, and aggregate, the risk. Such a third party should have made the appropriate investment – in terms of both funding and resource – into an effective mortality model and hold the financial capacity to manage such a longdated commitment. Stakeholders should consult widely before entering into any decision and make sure that any solution is durable as well as adaptable in the long term.
Recommendations for the insurance industry
Insurers can work together through their industry bodies and in partnership with their reinsurers to manage longevity risk effectively. As regulatory regimes, such as the European Union’s Solvency II, recognise reinsurance as appropriate mitigation against longevity risk, this will help them support capacity for annuities and other innovative products to fund people’s retirements. An important element of managing longevity risk will be the development of robust, predictive approaches, and a disease-centred model would help in this area. The significant investment and the expertise required to develop such an approach would mean that close relationships between insurer and reinsurer are vital. Reinsurers and insurers (re/insurers) should also work individually and together to educate potential investors and create demand for capital market solutions. This could address concerns over the finite longevity risk capacity in the insurance industry.
Recommendations for governments and regulators
Many governments in the industrialised world have recently increased state retirement ages in recognition of the significant improvements in life expectancy since pension benefits were first introduced. It is logical that retirement ages should relate to the expected longevity of citizens and more forward-looking approaches can help create a fairer system, along with demonstrating the differences in life expectancy between various groups within society. Governments can also share detailed anonymised data with appropriate parties on the prevalence of disease within their countries. They can then work with experts in mortality to achieve a more granular understanding of current and future mortality rates. This would help them develop plans for funding future state benefits. As with all employers, governments need to consider their options in carrying longevity risk – especially through providing defined-benefit pensions to employees – and decide whether or not it is appropriate to pass this risk onto a third party.
Under Solvency II regulation, EU insurers can propose internal models to evaluate their capital requirements, instead of relying on the standard formulae set by regulators. Models must be used in day-to-day risk assessment, calibrated to consider extreme scenarios and based on relevant, high-quality data. The forward-looking structure of a predictive mortality model is consistent with the demands of the regulators. Any scenarios must demonstrate the potential variability of outcome.
The realistic nature of this approach will be of interest to insurance and pension regulators in understanding the main drivers and risks for future experience.