Longevity risks and retirement outcomes

By Viresh Maharaj, Chief Marketing Actuary: Sanlam Employee Benefits and Andrew Rumbelow, Segment Head: Institutional Business

One of the most significant trends across the globe is the continuing increase in human longevity, mainly due to ongoing improvements in nutrition, public health and medical technology. But while improved longevity can be a gift, it is also a very big risk facing retirees and their finances and it will become even more impactful as time goes on…

The pressure on industry and trustees to provide relevant solutions at the lowest maintainable cost has never been greater. As custodians of the financial well-being of South Africans, we need to understand the changes that are taking place today, to structure a retirement system that best enables the retirees of tomorrow to lead fuller and more dignified lives.

Longevity in context

Longevity boom
Life expectancy at birth has increased by roughly 20 years since 1950 worldwide, a larger gain over the past 60 years than humanity has achieved over the previous six thousand years. The United Nations predicts that life expectancy will increase by 1.2 years for every decade over the next 50 years based on historic experience.  In other words, a child born 50 years from now is likely to live for 6 years longer than one born today.

Also, spending muscle, social capital and voting powers are all getting older …. There are 600 million people over the age of 65 right now, about 50% of all humans who have ever reached this age. This figure is anticipated to grow to 1.1 billion over the next 20 years. In South Africa, life expectancy is about 50 but would be more around 70 were it not for the effect of HIV/AIDS. However, recent evidence indicates that ARV treatments may be able to prolong an HIV positive individual’s life to up to 86% as long as an HIV negative individuals. This will affect SA’s demographic progression into the future and increase the proportion of older people in our country.

Science fiction is becoming science fact …
Technologies, including stem cell therapies, chromosome replacement therapies using nanotechnology, and the use of 3D printing to fabricate prosthetics, are rapidly changing the face of longevity as they will enable doctors to extend the quantity and quality of life to unprecedented levels.

The financial impact: What this means for retirement planning
These and other breakthroughs will all have a profound impact on our quality of life as people will be able to live far longer than we can reliably predict. The retirement industry as we know it will therefore change dramatically. In South Africa, those planning for retirement face shifting goalposts as the tools and projections currently being used to guide retirement planning are becoming outdated in the face of the trend of extended longevity. The assumptions historically used to plan for retirement will no longer be relevant, as not only are we living for far longer but we’ll be far healthier for far longer than our predecessors ever were. If we do not re-consider the retirement funding system in light of these changes, then South Africans will simply not have enough money by formal retirement to carry them through their much longer lives.

For institutions, funding these longer lives will also become increasingly difficult under current schemes and the sustainability of public and corporate pension schemes is at risk. The cost of funding state pension benefits is set to rise dramatically—by more than double in some countries. This poses a considerable political and economic dilemma about how to keep the burden on the working population bearable while not sacrificing the standard of living for those drawing pensions. Against this backdrop, we need to reimagine the retirement dilemma and apply creative thinking to arrive at potential measures that counter the impact of longevity on retirees.

What are the potential solutions?

Increasing retirement age
Extending one’s working life could potentially counteract the risk of increased longevity as it enables workers to increase their retirement savings, benefit from certain tax advantages for longer, reduce their time in retirement, and according to most gerontologists, improve the wellbeing of the elderly. Working South Africans will have more time to accumulate their retirement savings and will therefore reduce their relative strain on the government in old age and/or on their children. Furthermore, reducing the strain on younger generations by increasing the retirement age better equips younger people to create wealth for themselves and their children.

As an illustration, delaying retirement by 6 years would just about double your retirement nest egg. Delay for 10 years, and it triples.

Employers need to seriously consider increasing their retirement age policy in line with these increases in longevity. Employers can most certainly benefit from these ‘silver’ workers as they continue to share their years of superior expertise that would otherwise have been lost.

Retirement reform and government’s role in finding a solution
Increasing the retirement age alone will not alleviate South Africa’s retirement funding crisis as even now, 46% of South African pensioners actually took an early retirement package without fully understanding the financial consequences of doing so. As such, government may wish to consider the conditions under which early retirement may be taken to help individuals make better decisions that will lead to better outcomes in retirement. Government may also consider a focused strategy to addressing poverty in old age by introducing targeted poverty protection for lower income elders. Since poverty is much more prevalent among those aged 80 and over, Government should consider restructuring the state pension system as a “longevity backstop” that offers a greater benefit past a certain age, say 80.

Phased retirement and “Lifestage solutions”
Industry needs to develop solutions that allow for dramatically increased longevity, such as lifestage products. Lifestage portfolios are typically structured to provide members with higher exposure to growth assets the further away they are from retirement, and slowly reduce this exposure (in order to ensure capital protection) closer to retirement.

Lifestage products therefore provide a certainty of retirement income which can help employees retire with confidence. Finally, unlike traditional annuities, newer lifetime income products typically provide a death benefit, flexibility and control—all of which are attractive features to participants who have spent decades accumulating their retirement wealth. The first step in the retirement reform process has now happened, with a progressive change related to phased retirement introduced by National Treasury in March 2015. This allowa an individual to choose the date on which they retire from the pension fund, even if they retire from the company. In other words, the date on which the lump sum retirement benefit accrues to the individual should no longer be dependent on the normal retirement age, but instead should be the date on which the individual chooses to take the amount as a lump sum or annuity. So now individuals can extend their own date of retirement according to their own circumstances and when they prefer to start receiving their pension benefits, enhancing preservation and improving financial security in retirement.

Improved advice processes
It is critical for industry to provide enhanced retirement advice to various retirement fund boards of trustees, taking into account the impact of increased longevity and human behaviour. Similarly, trustees and principal officers need to better education their members in turn. Members need to be empowered to deal with the financial challenges that longevity poses (and make appropriate decisions) by being provided with appropriate investment and drawdown advice for living annuities and other nest eggs.

Increased accumulation of funds before retirement
An extended investment horizon means that members will need to carry extra risk (exposure to equities and other growth assets) in their retirement portfolios to generate sufficient returns to compensate for a longer lifetime in retirement.

Annuitisation (converting a lump sum investment into a series of income payments at retirement)
Guaranteed annuities reduce the risk of increased longevity for individuals. More recent products have been launched where a guaranteed number of units are paid to the individual for life, with the value of these units determined by the underlying investment portfolio. In this way, individuals can increase exposure to more risky assets such as equities to increase returns (and therefore future increases) while still having the guarantee of a secured income for life.

Automatic Enrolment (US & UK trends)
Automatic enrolment is a UK Government initiative to help more people save for their retired years through a compulsory pension scheme at work. Automatic enrolment makes it compulsory for all employers, regardless of their size, to offer workers a workplace pension, and was introduced in a bid to tackle concerns about poverty among retired people.

In addition, whereas previously workers had actively to sign up to their employer’s pension scheme – now, they must actively opt out.

Auto-enrolment has only been in existence for a few years, but figures show it has created 1.6 million more savers in workplace pensions, with a high take-up and a mere 9% of employees so far choosing to opt out. Under automatic enrolment in the UK, a portion of an employee’s pay packet is automatically diverted to a savings pot for their pension, assuming they are aged 22 or over and earning at least £9,440 a year. For each £100 an employee pays in under auto-enrolment, the government adds £25 and their employer adds £75. So, for a £100 personal investment £200 is paid into a pension, doubling the employee’s money. As part of this, auto-escalation allows for automatic increases in contributions by employee, government and company in line with salary increases and auto-preservation ensures that when an employee leaves the company, their pension savings are automatically preserved in a default savings fund and cannot be taken as cash. Here in South Africa, we default to the lowest contributions in our pension schemes, and employees must actively change to the higher contribution rate if they want to save more. Changing the rule of the retirement fund so that employees are defaulted to the higher contribution rates (“opted in”) could well be a viable consideration here.

Concluding thoughts:

Thanks to longevity, the goalposts have shifted … are still shifting

There is pressure to provide relevant solutions and structures … at the lowest sustainable cost

Trustees have a significant fiduciary responsibility to influence real change!

Solutions in brief: