This July, my grandmother will be turning 93 years-old. Despite the fact that she took lousy care of herself in her retirement years (poor diet, chronic weight problems, a heart attack, a stroke, and more than one bout with cancer), she stubbornly holds onto life. Her husband, my grandfather, died in 1992 at the age of 73. His parents both passed away in their 50s. My parents, who just turned 66 this year, will likely live to at least 105 according to current estimates. It’s possible that I’ll live to see the Tricentennial of America and its a foregone conclusion that my son will likely live to see the turning of the 21st Century, provided that he can maintain his good health.
One of the sources of my Grandmother’s income is her own pension as a veteran of the Camden school system as well as a survivors pension left to her by her late husband. It’s not much, but it helps to pay for whatever Medicare and Social Security cannot cover as well as a modest salary to my father who retired early in order to become her full-time care giver. Fortunately for her, the fund in which she receives her pension has a built-in guarantee that as long as she lives, she will receive her check every month.
That’s great news for her, but not-so-good news for the trustees of the pension fund.
The problem for pension funds all over the world is one of increased Longevity. When my grandmother’s pension plan was first designed, the average life expectancy was about 70 years. Therefore, if a person receives full benefits at the age of 65, it was assumed that the fund would only have to pay out its annuity for five years on average, but no greater than ten. At 93 years-old, my grandmother has outlived her plan’s expectations by 23 years! If her lifespan were simply an outlier, this wouldn’t be a problem, but her case is becoming much more common.
Changes to Pensions
Given what we know now, most private pension plans have switched from defined benefit plans to defined contribution plans. In other words, after a pensioner has run out of benefit, the checks will stop coming. This is good news for the trustees, but bad news for you should you happen to outlive your benefits.
Fortunately, (or unfortunately depending on your point of view), many life insurers are now providing seniors with added pension-like benefits if they agree to cash out their life insurance plans prior to their deaths. The downside of that plan is detailed in my previous article on “Death-Bet Securities”.
Pension Benefit Insurance
For those unfortunate pension plans with large numbers of guaranteed beneficiaries, (valued at $23 trillion at last count) they have the option of purchasing an insurance product that will continue to pay out benefits if those who are in the pool unexpectedly live longer than the plan was designed for. The problem with this type of insurance is that from an actuarial perspective, how can one adequately quantify the risk? After all, if longevity rates are changing all the time and the long-tail on this insurance product can stretch into decades, how can an insurance company predict with any degree of accuracy the correct premium verses risk?
One strategy that pension insurers are using is purchasing re-insurance on the pension insurance. What reinsurers can do is expand the pool of risk over multiple portfolios so that the chances of coming up with a more accurate risk analysis can be done. Unfortunately, according to Swiss Re, the worlds second largest reinsurer, they are also not so happy with the risk that this is taking on, so what they would like to see is a program to transfer the risk to investors by designing a derivative bond product on the risk pool. Munich Re, the world’s largest reinsurer, has decided to not offer this type of product due to the risk that longevity may become a systemic crisis in which reinsurers may be forced to take on.
The Sinister Side of Pension Insurance
On paper, pension insurance simply looks like good business practice. After all, if you find that part of your investment portfolio is taking on too much risk, you should do your best to transfer the risk to someone or something else. It worked for the subprime mortgage market, so why not a bet that pension beneficiaries will die sooner rather than later?
Wait a second! Didn’t the subprime mortgage market nearly destroy the world economy? Wasn’t the taxpayer made to be ultimately responsible for the poor decision-making and unwise transfer of risks to uninformed investors?
Incentives for Insurers
Another problem with this plan comes down to financial incentives. If insurance companies benefit if people die sooner rather later, then you possibly open the door for insurers to find ways to deny healthcare coverage to seniors in the hope that they will not find treatment for their illnesses. Therefore, they will die sooner and the insurance company realizes the benefit of not only saving money on a costly medical claim, but they will also realize a benefit by not paying out a pension benefit.
Incentives for Investors
What about the investor? They will realize a benefit if the pensioner dies sooner, but they don’t have the ability to affect the outcome of their longevity, right? What if the investor happens to be a less-than-ethical person? What if this investor happens to obtain the names and addresses of every senior citizen within a particular insurance policy they possess, and they have the means to “pay a visit” to those people?
What happens if the ultimate investor happens to be our own government? If like in the subprime mess the government becomes the “reinsurer of last resort” the government would need to take on the business and attempt to administer it using taxpayer money. It wouldn’t be any different from the current Social Security Program except this time they would have at least ten layers of non-transparency to sort through at a cost of millions more than the current program.
A Blessing and a Curse
We all would like to live forever. After all, death is a scary prospect and if we have the means to prolong life through medical technology or just taking better care of ourselves, why shouldn’t we live long enough to know our great-great grandchildren?
Unfortunately, by coming up with risk-transfer schemes in order to maintain the status quo, the large insurance companies are creating built-in financial incentives on an institutional scale for denying healthcare to seniors or worse. When those incentives can total in the tens of millions of dollars, the value that we place on human life will go down dramatically. When we consider a future like that, you have to wonder whether “living forever” is really worth it.Tweet