In late 2002 signs of a new flu pandemic emerged in Asia.
The first reported case of the often-fatal virus occurred in
China, spreading as doctors and other health care workers
traveled throughout Asia and beyond. By early 2003 severe acute
respiratory syndrome, or SARS, had infected hundreds of people
in 37 countries.
At about that time, Peter Nakada received a call for help.
Several global reinsurance companies asked Nakada, a risk
management expert who specializes in catastrophic events, to
create a computer model that would help them evaluate the
transmission and lethal potential of the new virus.
Nakada, who heads the life risks and capital markets units
of Risk Management Solutions (RMS) at the firms Hoboken,
New Jersey, office, built and delivered the software to his
reinsurance clients, then decided to shop it to the life
insurance market. That was when Nakada, sitting across a table
from the chief actuary of one of the largest U.K.-based life
insurers, learned of a new catastrophe. Though the flu software
was very interesting, the actuary said, SARS isnt
what keeps me awake at night.
What disturbed the actuarys slumber was not death but
life: catastrophic longevity. The risk that many more people
would live a lot longer than anyone had imagined had become the
scariest scenario in life insurance.
There is no doubt that over the past century life spans have
increased a trend that has accelerated in recent
decades. But when it comes to planning for retirement income
security, budgeting economic resources or even creating
shareholder value in public companies, expanding life
expectancy is wreaking havoc on balance sheets and heightening
financial risk for governments and individuals alike.
Its been recognized that mortality is
improving, says Zorast Wadia, principal and consulting
actuary on the pension-risk management team in the New York
office of actuarial consulting firm Milliman.
Theres no hiding that fact.
After his encounter with the actuary, Nakada returned to RMS
with a new mission: to build a risk model that would project
life expectancy for a given population. After two years of
research and engineering, RMS released a program with 10,000
hypothetical paths that could influence longevity. One key
finding revealed by the new model: There is a one-in-100 chance
that the average pensioner in the U.S., Canada and 13 other
developed countries will live five years longer than currently
projected by actuarial tables. Though the families of these
European, Australian and North American retirees will likely
welcome having them around, this unanticipated decline in
mortality will cost defined benefit plans a cool $1
Thats a crisis that makes SARS look small. And
its captured in the phrase longevity
MANAGEMENT CONSULTANT PETER DRUCKER famously once wrote,
What gets measured gets managed. Yet despite all
the attention paid to various flavors of risk besetting public
pension funds credit risk, interest rate risk,
market risk, currency risk longevity risk has not
been accurately measured, and it has not been managed well,
Investment risks have traditionally been the primary concern
of pension sponsors who manage large portfolios. More recently,
with the Federal Reserves quantitative easing program
holding rates at historic lows, interest rate risk has become a
greater concern. These low rates effectively reduced the
present value of future pension liabilities known as the
discount rate and increased the amount of assets needed
to fully fund future pension obligations. Add to that the
devastation to these portfolios wrought by the financial
crisis, and its easy to see how once-ignored longevity
risk became a big and growing problem.
The accuracy of the traditional mortality tables used to
measure life expectancy has been the subject of controversy,
particularly with the impending release of updated tables
assembled by the Society of Actuaries (SOA), an educational,
research and professional organization based in Schaumburg,
Illinois; the tables were last published 14 years ago.
Its a monumental task projecting future
liabilities, notes Amy Kessler, head of longevity
reinsurance for Prudential Retirement, a unit of Newark, New
Jerseybased Prudential Financial. When the new SOA tables
are officially published, later this year or in early 2015,
they will show that the median American is living 2.2 years
longer than just a decade ago. That means the average
65-year-old will live 22.7 more years, to 87.7.
In actuarial terms the new SOA data means pension fund
sponsors and individuals will need to set aside an additional 5
to 6 percent in assets, before factoring in inflation.
People are just coming to grips with this now,
In the U.S. alone, using only the current estimates of
mortality, actuarial liabilities include $3.6 trillion in the
126 largest public pension funds (closer to $4 trillion when
you fold in local and municipal funds), $3 trillion in private
defined benefit pension funds and $24.3 trillion in unfunded
obligations to current workers and retirees within the Social
Security program. Factoring in universal social security
systems in 170 other countries, Blackstone Group co-founder
Peter Peterson used $30 trillion in total global retirement
savings when he wrote Gray Dawn: How the Coming Age Wave
Will Transform America and the World in
1999. That number has grown a lot since then.
The International Monetary Fund argues that forecasters have
consistently underestimated how long people will live, over
time and across populations, regardless of the techniques they
have used. A 2000 report, Beyond Six Billion: Forecasting
the Worlds Population, says that
estimates have been too low in many countries,
including Australia, Canada, Japan, New Zealand and the U.S.,
by an average of three years.
The British have led the way in acknowledging, quantifying
and tackling longevity risk. The U.K. Pensions Regulator has
pushed for trustees and sponsors to employ the latest available
methods and techniques in setting demographic assumptions.
British actuaries use socioeconomic factors that influence life
spans, such as county of residence, type of employment,
housing, health care, education and diet, to gauge life
expectancy. The U.S. has not used these factors in a
Longevity risk has been much less visible in the U.S.
market, says Guy Coughlan, Pacific Global Advisors
chief risk and analytics officer, based in the firms
London office. The pension mortality tables have been
lagging behind the actual life expectancy.
Part of the problem in gauging longevity risk has been that
pension funds and others in the financial markets have
always depended solely on actuarial data that extrapolates from
the past. It has now become clear that actuarial tables do not
include the classic fund industry warning label: Past
results do not guarantee future performance. RMS was the
first to build a multifactor longevity risk model, which is now
used by life insurers, reinsurers and those developing
longevity-risk products in the capital markets. Among the many
factors that go into the design of a longevity-risk model are
estimates about the pace and duration of improvement in life
expectancy. As with climate change, the science encompasses
extremes. One side believes the human life span can and will
continue to grow. The other concludes there is an end point to
human longevity, an age beyond which it will not be possible to
But even if you do not believe longevity will extend
indefinitely no one is suggesting it isnt
improving, at least in the short run the need to
mitigate the future retirement income needs of a global
population is critical.
To meet those needs, an increasing number of
longevity-risk solutions and strategies are gaining steam,
from human-capital solutions to specialty financial products
designed by Wall Street, insurers and other purveyors of risk
mitigation tools. In the latest round of creativity, new
financial products are being packaged for sale to
endowment, foundation and
sovereign wealth investors as a way to profit from
longevity risk. The question is, Will these efforts improve
global retirement income security?
UNTIL THE MID-19TH CENTURY, HUMANS COULD expect to live
fewer than 40 years. In about 1900 life expectancy began rising
globally, reaching 48 years in 1950, 60 years in 1980 and close
to 70 by 2010, according to data from the United Nations and
The dramatic surge in life expectancy is mainly a result of
the decline in infant mortality, which accounted for more than
70 percent of improved life expectancies in Canada and the U.S.
from 1950 to 1970; other health care benefits aimed at people
under 65 also contributed. Death from infections was reduced,
while mortality as a result of chronic and degenerative
diseases at advanced ages increased.
Then, starting in about 1970, a significant improvement in
life expectancy for people over 65 began. It continues today,
with the largest effect on the oldest, those aged 85 and over.
The improvement in later life expectancy is the key factor in
the more recent upswing in longevity risk.
Will rapid mortality gains continue indefinitely or taper
off? On one side of the debate is Leonard Hayflick, a
microbiologist and professor of anatomy at the University of
California, San Francisco. He contends that science has not yet
discovered the fundamental causes of aging. The
resolution of causes of death tells you zero about the cause of
death, says Hayflick, a founding member of the National
Advisory Council of the National Institute on Aging, stressing
that wiping out cancer or heart disease will not add many years
to life expectancy. Patients cured of cancer in their 50s, 60s
or 70s continue to age. For the past 25 to 30 years, the
cause of death in the U.S. and developed countries is
essentially unknown for people over 80. People dont
die from a disease; they die with it. To increase life
expectancy, Hayflick concludes, the only other thing you
can do is tamper with the aging process.