Mon, May 02, 2005 - Page 9 News List

Longer lives mean more problems with pensions

By Robert Shiller

Living a long time is one of our deepest wishes, and medical and economic progress offers the hope that it will be fulfilled. Some scientists say that the average human lifespan could reach 90 years or more by mid-century. But what if our wish is granted? What good is a longer life if we cannot maintain our standard of living?

The fundamental difficulty in planning for enhanced longevity is that we do not know whether it will really happen. Life expectancy might well be only 80 years by mid-century -- about where it is now in advanced countries -- if medical progress is disappointing or is offset by new threats or hazards. If we make provisions for long lives that are cut short, we will have wasted huge amounts of precious economic resources. But if we fail to make provisions for lives that are longer, many elderly people will be condemned to poverty.

The whole direction of any country's economy depends on longevity. A huge number of elderly people would mean a lot of people wanting to live in certain locations, seeking certain kinds of living quarters, and consuming certain kinds of services. The types of corporations that will succeed, the buildings that are constructed, and the research and development that will be needed all depend on the demographics of demand.

This is true of the global economy as well. In his 2005 book The Future for Investors, Jeremy Siegel argues that differences across countries in longevity will interact with differences in wealth levels to form a fundamental determinant of economic relations among countries. Trade flows may be driven substantially by longevity: countries expecting a relatively large number of elderly in the future should be running trade surpluses now and deficits later.

Retired people need life annuities -- contracts that offer a stable income stream for as long as they live -- to insure against the risk of outliving their wealth. If there were no longevity risk -- that is, if the probability of dying at each age in the future were reliably known -- then pension funds could easily offer life annuities to large numbers of people by investing their assets in bonds of various maturities in order to pay out just the right amount each year.

But pension funds cannot do this, because they risk running out of money if, on average, people turn out to live longer than expected. For people retiring at age 60, the difference between living to 80 and living to 90 is enormous: in the latter case, their pensions would have to pay benefits for 50 percent longer. As a result, private companies do not offer life annuities at attractive rates, because they cannot be reasonably sure that they can fulfill their promises unless they are significantly overcapitalized.

Fortunately, financial markets are beginning to address longevity risk. In November 2004, the European Investment Bank (EIB), working with the private bank BNP Paribas, announced that it would issue the world's first long-term longevity bond. The bonds, with a maturity of 25 years, pay out an annual sum of ?50 million multiplied by the percentage of the English and Welsh male population aged 65 in 2003 that is still alive in a given year (subject to a slight data lag). For example, if 80 percent of the men are still alive ten years after issuance, the bonds will pay out ?40 million. If only 40 percent of the men are still alive after twenty years, the bonds will pay out ?20 million.

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