A number of Canadian pension plans are not putting aside enough money to account for the risk that people will live longer than expected, says a new report to be released on Monday.
Pensioners have become acutely aware of the toll that dropping stock markets and low interest rates are taking on pension plans, but many don't appreciate that one of the biggest risks is lengthening life spans, a trend that's accelerated thanks to medical advances and healthier lifestyles. And, although the risk facing pension plans is more dire, longevity is increasingly confronting life insurers as the baby boomers switch from buying life insurance to annuities.
More than $1-trillion of Canadian pension assets and annuity reserves face longevity risk, the report by reinsurer Swiss Re says. The vast majority of those assets are in corporate and public pension plans.
Swiss Re, which is hoping to convince pension plans and insurers to buy protection against this risk, clearly has an agenda in publishing the report, which it characterizes as the first comprehensive look at longevity risk in Canada. But the numbers are startling nonetheless. And if the company succeeds in creating an active market for longevity risks in this country, it might ultimately package those risks up into bonds or securities that are sold to investors. The report estimates that between $10-billion and $20-billion of longevity risk will be transferred from Canadian pensions and annuities to reinsurers and investors in the next decade.
Canada's longevity risk, at roughly five per cent of the total global amount, is relatively high because of the quantity of defined benefit pensions in this country, says George Graziani, a senior vice-president at Swiss Re in Canada.
"The liabilities of these plans in large part are being undervalued, largely because prospective mortality improvements are being understated," he said. "As human beings, it's a wonderful thing that people are living longer. But from a financial perspective the risk and the worry that we have about outliving our funds is a concern, and for our defined benefit pension plans that's a major concern."
Underestimating life expectancy by one year can increase the liabilities of a pension fund or an insurer's annuity business by as much as five per cent. "With a $1-trillion longevity risk, if you have people on average living just one year longer, that's about a $50-billion change," said Mr. Graziani. The longer an individual lives, the more that the pension fund or life insurer who has sold an annuity has to pay out to them.
Swiss Re argues that estimates of life expectancy are consistently shown to be too low. For example, in 1975 the UK Office of National Statistics expected male life expectancy in 2005 to be 71 years, but it turned out to be about 77 years. The Canada Pension Plan has increased its assumptions of life expectancy in each of its three most recent actuarial reports, adding billions of dollars to its unfunded liabilities.
Research suggests that a large proportion of Canadian pension plans base their life expectancy assumptions on figures that come from the death rates in the U.S. civil service in the late 1980s, but Canadian life expectancy is higher than that in the U.S. While the pension plans adjust the numbers to account for longer lifespans, Swiss Re argues that they are not being conservative enough.
Life expectancy at birth in the developed world has risen from about 65 years in 1950 to more than 75 years now. Life expectancy in Canada is expected to surpass 90 years by 2100. In 2001, out of 10,000 sixty-year-old Canadian males alive at the start of the year, 100 were expected to die during the year. By the end of 2001, only 97 were expected to die.
It's a risk that's competing for attention during the current market turmoil. A survey by RBC Dexia Investor Services released last week suggests that Canadian pension assets fell 5.5 per cent in the three months to the end of September.
"Ongoing uncertainty over Europe's sovereign debt crisis, a U.S. downgrade and mounting fears of slower global economic growth drove pensions to their lowest quarterly result since the 2008 financial crisis," said Don McDougall, director of advisory services for RBC Dexia.