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The Challenge of Longevity Risk: Making Retirement Income Last A The Challenge of Longevity Risk Making Retirement Income Last a Lifetime October 2015 Contents About our organisations ...................................................................................ii Overview ................................................................................................................1 Managing longevity risk ...................................................................................3 Five principles .......................................................................................................5 Appropriate defaults at decumulation ........................................................8 Guidance and advice ...................................................................................... 11 Conclusions ........................................................................................................ 12 Appendix A: Overview of the Australian system .................................. 13 Social security ................................................................................................ 13 Private pension provision .......................................................................... 13 Taxation of private pension savings ...................................................... 14 Decumulation ................................................................................................ 14 Financial literacy, guidance, and advice ............................................... 15 Future of financial advice (FoFA) ............................................................. 16 Appendix B: Overview of the UK System ..................................................17 Social security ................................................................................................ 17 Private pension provision .......................................................................... 18 Taxation of private pension savings ...................................................... 18 Decumulation ................................................................................................ 19 Budget 2014 ................................................................................................... 20 Financial literacy, guidance, and advice ............................................... 21 Appendix C: Overview of the US system ................................................. 22 Social Security ............................................................................................... 22 Private pension provision .......................................................................... 22 Taxation of private pension savings ...................................................... 24 Decumulation ................................................................................................ 25 Financial literacy, guidance, and advice ............................................... 28 References ........................................................................................................... 29 i The Australian Actuaries Institute, the Institute and Faculty of Actuaries in the UK, and the American Academy of Actuaries believe there is a common theme in all three countries: longevity risk is not well understood by many people and this lack of understanding can have significant implications for retirement income, particularly as longevity increases. About our organisations AUSTRALIA with employers to encourage and develop their Actuaries Institute actuarial employees to better themselves, the The Actuaries Institute (Institute) is the employer and the financial sector. As part of our professional body representing the actuarial core strategic objectives we aim to inform and profession in Australia. The Institute is influence existing public policy development, committed to promoting and maintaining with contributions based on evidence and our a high standard of actuarial practice and expertise. represents and supports its members by: • educating the next generation of actuaries and UNITED STATES ensuring skills and knowledge are constantly American Academy of Actuaries developed through continuous professional The American Academy of Actuaries (the development; Academy) is the national association for the • establishing and maintaining strict actuarial profession in the United States. professional and ethical standards; The Academy is a Washington D.C.-based • fostering a strong professional network and 18,500-member professional association whose promoting and advancing knowledge in mission is to serve the public and the US specialist areas of actuarial science through actuarial profession. Academy members include research and events and seminars; and actuaries employed as consultants, corporate • contributing to public policy through policy executives and staff, regulators, government submissions, thought leadership and expert officials, academicians, and retired actuaries. analysis. Their areas of practice cover pensions, life insurance, casualty insurance, health insurance, UNITED KINGDOM financial reporting, risk management, and Institute and Faculty of Actuaries more. The Institute and Faculty of Actuaries (IFoA) is the UK’s only chartered professional body The Academy assists public policymakers on dedicated to educating, developing and all levels by providing leadership, objective regulating actuaries based both in the UK and expertise, and actuarial advice on risk and internationally. We represent and regulate our financial security issues. The Academy also members for the benefit of the outside world sets qualification, practice, and professionalism and oversee their education at all stages of standards for actuaries credentialed by qualification and development throughout one or more of the five US-based actuarial their careers. As a professional body we work organizations. ii critical decision. An equally essential decision Overview is how to spend down one’s retirement assets— this is referred to as the “decumulation” phase This paper concentrates on longevity risk in of retirement. (Other terms commonly used the context of the retirement income system in for the decumulation phrase are the “pension Australia, the United Kingdom (UK) and the phase” or “drawdown phase”.) United States (US). While there are differences in our social security, taxation, pension As people save, and subsequently come to savings and retirement income frameworks, spend their retirement income, investment, the Australian Actuaries Institute, the Institute inflation, and personal spending risks (such as and Faculty of Actuaries in the UK, and the long-term care needs) are incredibly important. American Academy of Actuaries believe there Longevity presents another critical risk, is a common theme in all three countries. particularly around the risk of living to very Longevity risk is not well understood by many advanced ages with depleted financial assets. people and this lack of understanding can have significant implications for retirement income, Attempts by policymakers to tighten rules particularly as longevity increases. around eligibility for state benefits are increasing pressure on individuals to become There are five principles that With rising life expectancy, saving more self-sufficient in retirement. All three frame the challenges of sufficiently for an adequate income in countries have implemented policies that managing longevity risk: retirement is increasingly important. encourage an increase in occupational pension This is compounded further still as, contributions (examples in particular countries Adequacy in many countries, there has been include compulsion, auto-enrolment, tax a shift away from Defined Benefit incentives and incentives to work beyond the Information (DB) pensions, in favour of Defined eligibility age for social security retirement Flexibility Contribution (DC) plans. This shift benefits) with the policy intent of sharing is transferring responsibility for the cost of funding retirement between the Equity managing longevity risk—alongside government, employers and individuals. investment and inflation risk— Sustainability to the individual. Furthermore, the political appetite for changes to the decumulation phase of retirement is The opportunities and challenges of an ageing evident, even if each country is not necessarily population are significant for policymakers, pursuing the same course in each region. The for business and for individuals. Over the Financial Systems Inquiry (FSI) in Australia course of a lifetime people make financial has recently concluded that decumulation of decisions. Saving an adequate amount for private DC schemes “is underdeveloped and retirement (frequently through DC plans), does not meet the risk management needs of the “accumulation” phase of retirement, is one many retirees” (FSI, 2014). Meanwhile, the UK THE CHALLENGE OF LONGEVITY RISK | 1 government has moved away from mandating decumulation. In the context of longevity risk, the purchase of annuities, increasing personal a critical element is ensuring that people can choice and considering reform to the taxation make their money last a lifetime. In supporting of pensions. In the US, policymaking and people to do this, products that offer an regulatory bodies have made efforts to facilitate income guarantee, or decumulation processes individuals to seek guaranteed lifetime income that provide reasonable assurance that the options for decumulation of DC plans, but individual will not outlive his or her assets, as yet have
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