Welcome to The Harris Pension Chronicles.
In my last post, I wondered whether prosperity necessarily follows from a longer life. Focusing on your employees and their increasing life expectancy, I concluded that most Canadians need to engage in more sophisticated retirement planning if they hope to enjoy all those extra years of retirement with greater financial security. This is not the end of the story though, as the flip-side is that employers too need to recognize the 'longevity risk' and take proactive steps to address that risk.
What the numbers tell us
The Canadian Institute of Actuaries (CIA) recently released a draft report on Canadian Pension Mortality with a view to replacing their current longevity assumptions created with data from the 1970's. These assumptions are used by actuaries to calculate pension plan liabilities. Both the U.S. and the U.K. recently updated their longevity assumptions; Canada is simply following suit.
By their nature, defined benefit pension plans (DB Plans) are exposed to the risk of higher than expected payouts because of increased life expectancy among pensioners – called 'longevity risk'. Generally speaking, greater life expectancy translates into increased going-concern liabilities, with the actual size of the increases dependant on specific plan membership characteristics. Precise measurements of longevity risk are unavailable due to limits on our ability to quantify the impact of improved lifestyle choices and modern medical technology on life expectancies. So actuaries must use longevity assumptions when calculating DB Plan liabilities.
The draft CIA report makes for some pretty dull reading and is only recommended for those suffering from acute insomnia. For those that can sleep, I summarize the draft CIA report as follows:
'Canadians are living longer than ever before.'
According to the Human Mortality Database, Canadian life expectancy rose 27% between 1939 and 2009. More important from a retirement planning perspective is that, according to that same database, life expectancy for Canadians who reach normal retirement age (65) has increased significantly over the last 80 years. To illustrate, I created the chart below using Canadian data.
In 1933 an average Canadian female reaching the age of 65 was expected to live an additional 14 years (to age 79) while today she would be expected to live an additional 21.8 years (to age 87). A difference of 7.8 years or about 56% longer. For men, the difference is 5.8 years or about 45% longer. This means that Canadian men and women retiring at age 65 today need sufficient savings to see them through about 20 years of retirement.
Keep in mind that we are dealing with averages, so men and women blessed with good genes had better have something extra in reserve in case they live well beyond the average life expectancy.
HSBC recently commissioned a global retirement trends study intended to provide insights into key issues relating to aging populations and increased life expectancy. The results of the study appear in 'The Future of Retirement: Life after work?'. Strikingly, the study concluded that 17% of Canadian workers (nearly 1 in every 5) believe they will never afford to fully retire. The figures for the U.S. and the U.K. are 18% and 19% respectively, with a global average of 12%.
What this means for Employers
Increased Canadian life expectancies and the pervasive feelings of uncertainty and pessimism among 1 in 5 Canadian workers have serious implications for employers.
Employers who sponsor DB Plans may need to adjust their funding targets or plan designs to address greater life expectancies. They can also use "swaps" or insurance contracts to hedge longevity risk in their DB Plans. These complex contracts come with their own risks, so they are not necessarily a panacea for all ills created by increased life expectancy. The federal pension regulator, OSFI, recently issued a draft policy advisory entitled 'Longevity Insurance and Longevity Swaps' on how pension plans can effectively use these types of hedges.
Unlike their DB Plan cousins, defined contribution plans (DC Plans) are not exposed to longevity risk per se, as that risk is borne by plan participants. Nevertheless, employers who sponsor DC Plans may need to review contribution rates and investment options to ensure their plans continue to meet design objectives.
Employers should be concerned about the retirement fears of their employees. Retirement anxiety may result in distracted, unmotivated, employees remaining in the workplace well beyond their normal retirement age, thereby reducing productivity and opportunities for advancement for younger workers.
Regardless of the type of retirement savings vehicle offered through work, employers can assist their employees through improved communication and education, to ensure that they understand the real financial and lifestyle implications of longer-than-expected retirements. New employees should be encouraged to save for retirement as soon as they join an organization; perhaps through mandatory participation in retirement programs. While the old proverb "you can lead a horse to water ..." generally holds true when it comes to retirement savings, communication, education and mandatory participation can at least serve as appetizers for even the most stubborn horse in the barn.
The Chronicles Take-Away
Canadians are living longer and this fact has implications for employers, especially in the area of pensions and retirement planning. Concerned employers should consider ways to increase retirement savings through a combination of better communications, access to financial education, greater savings initiatives and improved investment results. And they should consider ways to transfer longevity risks to others better able to manage those risks.
Employees should be encouraged to assess their retirement plans and, where needed, seek professional assistance so that they can enjoy their retirement years with greater financial security.
Stay Healthy, Wealthy & Wise
Issue 3, Volume 1
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.