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The Financial Impact of Longevity Risk – 2012

Overview

As the U.S. grows older, more financial resources will be expended to meet the needs of an aging population base. Just how much will be expended depends on reliable forecasting. Forecasting must be accurate in order to adequately prepare for changes in both expenditures and revenue. This report by the International Monetary Fund (IMF) indicates that most projections do not factor in “longevity risk,” meaning that because people will live longer, governments will pay longer (and therefore more), impacting revenue available for everyone.

In particular, not factoring in longevity risks impacts state pension plans, which could require more money than currently planned. Longevity risk could also impact funding requirements by states for Medicare/Medicaid resources. Longevity risk is no small financial risk. For example, “if individuals live three years longer than expected – in line with underestimations in the past – the already large costs of aging could increase by another 50 percent” (page 1). As state and local governments prepare for an older demographic, this report suggests new thinking for some of those calculations.

Key Points

The report offers three approaches to addressing longevity risk. These include: 1) an honest assessment by governments of longevity risk on existing financial projections; 2) the even distribution of risk by individuals, governments and businesses; and 3) transferring longevity risk to capital markets.

Other highlights include:

  1. The IMF report urgently recommends immediately raising the retirement age. Retirement ages should be “linked to advances in longevity” (page 2), rather than current forecasting models.
  2. Longevity risk projections should not only include historical data but should be adjusted to include “recent longevity data” (page 6). IMF rationale is that historical data isn’t necessarily the best predictor of future trends. By using historical data in combination with current research, forecasting will become more accurate. One example listed in the report relates to longevity predictions for HIV patients, which at one time were abysmal. Basing longevity risk predictions on history alone does not factor current advances in medicine allowing for longer life spans for those living with HIV (page 7).
  3. The impact of longevity risk as a percentage of GDP (page 8), the financial stability of the macro-economy (page 10), or on Defined-Benefit Plans (page 13) are all provided in the report, along with exposure risks between public and private sectors (page 16-19). But for local governments seeking to understand their role in fostering solutions like longevity bonds and insurance solutions, the “Role of Government” section (page 24) is especially helpful. IMF recommendations in that section include providing detailed longevity data, enhancing regulation and supervision, and improving the education of market participants.

How to Use

Budgeting requires forecasting. Especially on state levels, where forecasting is critical to funding projections, this IMF report crucially points out implications longevity forecasting has on state pensions. With greater numbers of older adults entering into retirement, this can mean a significant percentage of the future budget, particularly if longevity is underestimated. This IMF report suggests that merely living three years longer has massive implications locally. Local governments can use this report to reassess their own forecasts and financial planning estimates for defined benefit pension funds.

View full report: The Financial Impact of Longevity Risk – 2012 (PDF – 1.1 MB)

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