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Longevity the Ultimate Risk for Ageing Populations, says John Piggott

Singapore Management UniversityInstitutional Knowledge at Singapore Management UniversityKnowledge@SMU Office of Research2-2009Longevity the Ultimate Risk for AgeingPopulations, says John PiggottKnowledge@SMUFollow this and additional works at:http://ink.library.smu.edu.sg/ksmuPart of theInsurance CommonsThis Journal Article is brought to you for free and open access by the Office of Research at Institutional Knowledge at Singapore ManagementUniversity. It has been accepted for inclusion in Knowledge@SMU by an authorized administrator of Institutional Knowledge at SingaporeManagement University. For more information, please emaillibIR@smu.edu.sg.CitationKnowledge@SMU, "Longevity the Ultimate Risk for Ageing Populations, says John Piggott" (2009).Knowledge@SMU.Paper 190.http://ink.library.smu.edu.sg/ksmu/1907/21/12 Longevity the Ultimate Risk for Ageing Populations, says John Piggott - Knowledge@SMU1/3 knowledge.smu.edu.sg/article.cfm?articleid=1187   (http://knowledge.smu.edu.sg)Longevity the Ultimate Risk for Ageing Populations, says John PiggottPublished: February 03, 2009 in Knowledge@SMU Life expectancy has been increasing for many decades, and most rapidly in the last 50 years. Life expectanciesare expected to continue climbing over the next 50 years. As people age, they are less able to earn a living andmust live off their savings. These are increasingly likely to be inadequate as life spans increase. Most personsunderestimate how long they will live and the savings required to get them there.John Piggott, research dean at the Australian School of Business, University of New South Wales, and director of theAustralian Institute of Population Ageing Research, spoke on “Confronting the Ultimate Risk: Longevity in the 21stCentury” at a seminar on the future of silver security organised by the Sim Kee Boon Institute for FinancialEconomics, Singapore Management University.According to Piggott, the United Nations shows the world population pyramid did, in fact, look like a pyramid in 1950.Most of the population was in the lower age groups, and it tapered off steadily for older age groups. By 2005, UNdata shows that the global population pyramid was looking more “boxy”. Old-age groups at the top of the pyramidhad expanded. Japan has one of the world’s oldest populations, making it ideal as an indicator of the world’s future age distribution.In 2005, Japan’s population was “fattest” in the middle. The age group which has grown the most and is now thelargest is 50 to 59 years. All ages above 59 years had increased more rapidly than those below. The UN estimates that by 2050, the 75 to 79 year age group will be Japan’s largest. The problem is that without asubstantial increase in savings by this group, younger age groups will be required to support them.Solutions to Longevity RiskWhile there are no easy solutions, the most promising appears to be longevity insurance, annuities, variable annuitiesand reverse mortgages. So far, none have proven very popular. Information asymmetry and adverse selection havereduced the efficiency of annuities and reverse mortgages markets. Phased withdrawals have met with the mostsuccess. They serve as a disciplined savings plan by requiring annuitants to withdraw savings in fixed amounts atpre-set intervals. Otherwise, a risk is that retirees would spend down their retirement wealth too quickly.As Piggott noted, “Life expectancy is increasing everywhere. In most OECD countries, male life expectancy over 75has increased 12% since 1960. In Asia, life expectancy has moved from 41 in 1950 to 61 in 1980. In China, formales, it has moved from 39 in 1950 to 61 in 1980. For females, it has moved from 42 in 1950 to 67 in 1980.” Duringthis time, he said, fertility rates also dropped. These two factors have combined to increase the expected“dependency ratio” (wage earners divided by retired population) from 23% today to 42% in 2030. Piggott pointed out that the solutions typically fit into five categories and there are problems with each of them:1) Personal resources. Piggott said: “Savings are often inadequate because many persons fail to save enough, retiretoo early and lack insurance. In addition, most wealth is locked into the family home.”2) Family resources. In Asia especially, it is common to view the children as one’s pension. With increased labourmobility, however, the parents and grandparents may be left behind. There are also cultural changes regarding theresponsibility of caring for the aged.3) Work longer. This seems to be a natural and easy solution. There may be institutional constraints, however, suchas company policies to retire at a certain age such as 62 or 65. Another problem is health issues and vigour, whichoften decline in later years.4)  Social Security. As Piggott notes, “Most countries have defined benefit schemes. These are typically under-funded, which places a stress on the country’s revenues. In some countries, like the US, social security paymentsare nearly certain to be reduced in the future.”5) Occupational pension plans. The “defined benefit” plans of many companies are under stress or insolvent(because liabilities exceed assts, especially in the currently depressed stock markets). A Picture of Mixed SuccessOf course, it takes a burden off governments if it can switch to a “defined contribution” scheme. It means7/21/12 Longevity the Ultimate Risk for Ageing Populations, says John Piggott - Knowledge@SMU2/3 knowledge.smu.edu.sg/article.cfm?articleid=1187employees will get back what they contribute to their retirement plan, with interest. The government does not needto fund it.As Piggott observed, “In the last 20 years, 19 countries have switched their retirement schemes from definedbenefit to defined contribution. They include Chile, Switzerland, Netherlands, Australia, Argentina, Columbia,Denmark, Peru, Uruguay, Hungary, Kazakhstan, Bolivia, Mexico, El Salvador, Poland, Hong Kong, Sweden, Latvia andDominican Republic.” Singapore’s CPF scheme has always been a defined contribution plan. It means there is no over or under-funding forthe government to worry about. In contrast, US Social Security is a defined benefit plan. It specifies how muchemployees will receive over their lifetime. Payments are tied to their contribution but there is no one-to-onecorrespondence and persons who live longer will receive more.Many will take out more than they put in, and this has led to under-funding of the US Social Security system. It willbe remedied by reducing payouts or increasing contributions, possibly from taxpayers. Of these two choices,reducing payouts is the more popular, and is being implemented now. The “full retirement” payout age has beenincreased from 62 to 65 and there are incentives for retirees to wait longer for their pension, up to age 70. A natural solution to the problem of a retired person receiving a defined contribution payout and not spending itwisely is phased withdrawals. No matter how payouts are staggered, however, they almost certainly will not coincidewith the retiree’s life span.Because they have no longevity insurance element, phased withdrawals fail to deal with the problem of longevityrisk. It is usually dealt with in other ways, the most typical being reliance on relatives and subsistence pensions.Taking care of elderly relatives is a centuries-old solution. It may be less relevant today because of increasedmigration, causing many children to live away from their parents. As for subsistence pensions, most westerngovernments provide them and it has become the ultimate safety net for long-lived retirees.Another solution is reverse mortgages. Since most retirees have most of their wealth tied up in their houses, alogical solution is to sell. The problem is that will leave them without a place to live. As Piggott noted, “Reversemortgages allow the retiree to mortgage their home and draw a gradual pension on the mortgage.” At death, thehome may be sold with the sale proceeds split between the lender and beneficiaries. Or the beneficiaries can buyback the home at death of the retiree. The retired borrower also has the option to “change his mind” and pay offthe mortgage early, before death.Interest rates on reverse mortgages are typically close to personal lending rates and about 50 % higher thanconventional mortgage rates. Reverse mortgages have met with mixed popularity. Piggott provides the data: “TheUS has the largest potential reverse mortgage market with 6.7 million households. The actual number of reversemortgages was about 40,000 in 2004. The number of reverse mortgage lenders was about 200.” He notes that, “Thescheme received a boost in 1989 with the Home Equity Conversion Mortgage (HECM) program. It provides lenderswith mortgage insurance in case the loans exceed the property values.” Smaller reverse mortgage markets exist in Australia, Canada and the United Kingdom. They do not enjoy governmentsponsorship similar to HECM. In Singapore, the only reverse mortgage lender, NTUC Income, stopped issuing reversemortgages in 2008. The Singapore government, however, has offered a similar program for low income groups -- areverse mortgage scheme for 3-room flats.On the demand side, reverse mortgages have not met with much success, possibly because many retirees perceivethem as taking away their home and/or denying them the chance to leave a bequest to their beneficiaries. On thesupply side, many lenders have shied away, citing longevity risk since the property cannot be sold until the borrowerdies. There is also the risk outside the US (where HEMC provides free insurance against this risk) that the home price mayfall below the mortgage value. When the loan is sold “without recourse”, which is common, the lender must take aloss. If sold “with recourse”, there is an unpleasant administrative problem of repossessing a home from an elderlycustomer.Annuities Offer PromiseAnnuities would seem to be a logical solution to the problem. The retiree gives a fixed sum which purchases agradual payout over the retiree’s lifetime. An uncommon variation is for the amount that is left over at death to bereturned to beneficiaries.More typical and less costly is for the amount remaining at death to go to the common pool used to pay otherannuitants. The problems have been moral hazard and adverse selection. Persons who are healthy will find theannuity too expensive. Those who are not healthy will buy, pushing up costs to the insurer.According to Piggott, “This information asymmetry is remedied somewhat by medical exams, although it is usually not7/21/12 Longevity the Ultimate Risk for Ageing Populations, says John Piggott - Knowledge@SMU3/3 knowledge.smu.edu.sg/article.cfm?articleid=1187A ll materials copyright of Singapore Management University (http://www.smu.edu.sg) and the Wharton School (http://www.wharton.upenn.edu) of theUniversity of Pennsylvania (http://www.upenn.edu), Privacy Policy (http://knowledge.smu.edu.sg/privacy.cfm).enough and adverse selection remains. It is similar to the adverse selection problem in health insurance.” An alternative is variable annuities. They are analogous to defined contribution plans and they push the longevityrisk to the buyer. The annuity received depends on payouts of stock and bond investments. A subtle variation isGroup Self-Annuitisation (GSA), which is a variable annuity that adjusts to unanticipated changes in mortality rates. Dividends paid to annuitants reflect (i) investment performance as well as (ii) mortality experience of all annuitants.Piggott points out, however, that “In practice, there are few adjustments from mortality changes. Payments mostlyreflect the investment experience, very much like variable annuities.” An Under-served MarketLongevity insurance products are under-produced. There is an enormous need for products which allow investmentrisk exposure combined with longevity insurance, said Piggott. The most hopeful directions seem to be some sort ofvariable annuities and reverse mortgages although the market is telling us there may be obstacles since they havenot yet caught on with annuitants. (#top) (#top)

Longevity the Ultimate Risk for Ageing Populations, says John Piggott

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