Longer Life Spans - Bigger Pension Liabilities
According to economist John Maynard Keynes, "In the long run, we're all dead." That may be but the long run is getting longer. The Centers for Disease Control and Prevention report that "life expectancy for Americans has reached an all-time high" with women expected to live to 79.9 years and men giving way around 74.5 years. The good news is not unique to the U.S. More than a dozen countries have a life expectancy at birth of more than 80 years. What accounts for the female factor? Researchers Daniel Kruger and Randolph Nesse offer that men take more risks than women, exposing themselves to danger, especially in their twenties. (The gap seems to narrow over time.)
Living longer could be a blessing or a curse. Liz Pulliam Weston makes a compelling case that women are in retirement crisis mode. She warns that the fairer sex is likely to experience job discontinuity (and related income diminuition), earn less on average, outlive a spouse and save too little. Then there's a marriage penalty since "Single women are four times more likely than couples to live in poverty."
In pension land, longevity spells trouble. Plan sponsors find themselves in the unhappy position of having to fund benefits for an additional period. A KPMG study estimates a 2005 pricetag for British companies of "an additional 20 billion pounds in pension liabilities".
Longevity derivatives offer some hope. One form, annuity bonds, pay coupons that are linked to a pre-specfied survivorship index. From an investor's perspective, a low correlation with traditional offerings has appeal. Mortality bonds are another possibility. According to Kevin Dowd, one bond paid principal based on an international mortality index with a "generous floating coupon payment in return for accepting the risk of a reduced principal payment in the event of a catastrohic mortality deterioration". Yet another variation, still in its infancy, is the longevity swap. The outlook is mixed. In "The Grave Problem with Longevity Risk", professor Dowd describes advantages and disadvantages of this emerging market.
If actuarial predictions prevail, financial engineers could be extremely busy. Companies and governments will need help in managing pension and post-retirement healthcare benefits that are growing with kudzu-like speed.
