A matter of facts

Pensions and life expectancy
June 3, 2009

It should be no surprise when forecasts are way off the mark. What is surprising is to find systematic over or under-prediction lasting for several decades. A good example is life expectancy. For very many years now, the life expectancy of men in Britain has been rising at the rate of three months per year, with that of women rising somewhat more slowly. What is startling about this fact is the sheer stability of this rate of increase. Most people imagined that it would slow down at some stage since it plainly cannot go on for ever. The government actuary's department was no exception and its projections have systematically under-predicted the actual outcomes since the early 1970s. For example, the 1986 projection of life expectancy for men in 2004 was around 2½ years too low.

The facts of rising life expectancy and its under-prediction have big implications for pensions. If life expectancy is rising and annual pension incomes keep pace with earnings, then in a funded scheme the retirement age and/or the pension contribution must rise. In a defined benefit scheme, annual pension incomes keep pace with earnings almost by definition.

For some years, however, the consistent under-prediction of the rise in life expectancy came to the rescue of pension schemes because it made it appear that contributions would not have to rise too rapidly. Indeed when the stock market was rising, the under-prediction led to companies being advised to reduce or cease percentage pension contributions. The fact that elderly pensioners insisted on remaining alive beyond their expected term eventually undermined this state of affairs. Indeed, because of the previous pension holidays, contributions or retirement ages would then have had to rise even faster to keep pace with life expectancy. For many companies this was all too much. Defined benefit schemes were scrapped and replaced by defined contribution schemes where prospective pension incomes would simply adjust downwards as life expectancy rose. Indeed the fact of steadily rising life expectancy has still not really been faced. "Save more" and "retire later" are not popular slogans.