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Home > Blogs > Anthony Harrington > Longevity risk could compound state debts says BIS

Longevity risk could compound state debts says BIS

Longevity risk could compound state debts says BIS Anthony Harrington

One of the most destabilizing factors facing the developed world is the thorny question of unfunded state promises to the aged. There is an expectation in many countries that the State will provide a safety net for the aged, ranging from affordable or free healthcare up to and including whatever geriatric and end-of-life care might be necessary, including residency in care homes and so forth. When these promises are quantified and projected forward, the resulting picture looks completely unsustainable. Yet politicians dare not retreat too precipitately from their promises to the aged, since demographics have given "the grey vote" a tremendous power. The elderly voters increasingly have numbers on their side and can literally make or break a candidate's political campaign.


A recent consultative report by the Bank for International Settlements (BIS), entitled Longevity risk transfer markets: market structure, growth drivers and impediments and potential risks, sets out to get a meaningful debate going in the employer-funded defined benefit pensions market. As the report notes:

"The ageing population phenomenon being observed in many countries poses serious social policy and regulatory/supervisory challenges. Not only are people living longer, but longevity risk – the risk of paying out on pensions and annuities longer than anticipated – is also becoming more of a concern in terms of sustainability of existing “saving for retirement” products."

The issue of longevity risk transfer might seem quite a long way away from the unfunded state promise debate, but the two come together on at least two fronts. As the BIS paper notes, if regulators and insurers get it wrong and the entity underwriting the longevity risk transfer fails to honor its contract, you get two negative outcomes: first, you get a massive bankruptcy in the financial sector with possible systemic implications; second, you get a potentially large number of pensioners which the State would have regarded as being self-funded, and hence not a burden on the state, becoming a burden. Remember that the sums required to support a pensioner who lives thirty to forty years beyond retirement are very considerable.


The BIS spells out that cost as follows. Each additional year of life expectancy adds around 3-4% to the present value of the liabilities of a typical defined benefit pension fund. The total global sums involved in annuities and pension-related longevity risk exposure is anywhere from $15 trillion to $25 trillion, the BIS says. That being so, getting a cohort's longevity wrong by one year, i.e. underestimating by one year the average survival length of scheme members, adds around $450 billion to $1 trillion to the aggregate bill facing longevity risk holders. Where longevity risk has not been transferred, the holder is the defined benefit pension scheme, its trustees and the sponsoring employer. Where it has been transferred, the risk falls on the insurance companies or financial markets standing behind the transfer.


One can easily imagine a series of health improvements which, on average, increase scheme members' life spans by five years over the next ten years or so, which would, at a stroke, add $5 trillion of unfunded, unexpected debt to the bill facing risk holders. It is easy to imagine that this could aggregate up to be catastrophic for even the largest players. The BIS consultative paper is essentially a wake-up call to regulators to recognize that there is a serious danger lurking "out there". The BIS has a long list of checks it wants regulators to make on the financial health and viability of entities going in for longevity risk transfer deals and it is mildly worried about the fall out that could happen if the industry's guestimates about our longevity turn out to be wildly short of the mark.


Again, however, the sums involved are so large that one wonders quite what could possibly be done if the wheels really do come off, and modern medicine and research produce sprightly geriatrics who rediscover the vigor of their forties and fifties and just keep trucking on. More state bailouts seem completely out of the question since most modern states have already done their boots and buried themselves in debt. We have some very interesting times a-coming, it seems...

Further reading on public sector debt




Tags: Bank for International Settlements , BIS , demographics , grey vote , longevity , longevity risk , Pensions , Public Sector debt
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