It’s official — not only are Canadians getting older, we’re also living longer. Last week, the Canadian Institute of Actuaries (CIA) released a draft set of updated mortality tables, used by actuaries to measure pension plan liabilities, or the amount of money needed to pay current and future pensioners. According to the study results, which are based on a review of recent pensioner mortality rates and future life expectancy improvements anticipated by the study’s authors, the life expectancy of a 60 year old male today has increased by 2.9 years (from 24.4 to 27.3 years) compared to pension mortality tables currently in use. The life expectancy of a 60 year old female has increased by 2.7 years (from 26.7 years to 29.4 years).
While long life is usually a good thing, it has significant implications for sponsors of defined benefit (DB) pension plans, which typically pay a pre-determined pension for the life of the retiree. As life expectancy increases, plan sponsors will need to cover higher numbers of pensioners for longer periods of time, increasing pension liabilities and requiring larger pension contributions. Although the effect will vary from plan to plan, adoption of the proposed mortality tables and acceptance of the study’s prediction of future mortality improvements could also immediately increase pension accounting liabilities by 5% to 10% for many plans, potentially impacting corporate income statements and balance sheets.
“This study highlights the risk that increasing life expectancy can pose for DB plan sponsors” said Gavin Benjamin, a senior retirement consultant at Towers Watson. “Just as sponsors were beginning to see a reduction in their pension deficits due to improvements in the global equity markets and rising interest rates this year, the increase in life expectancy suggested by the CIA study could reverse much of this gain.” However, plan sponsors can start preparing for the implications of the study. Benjamin suggests, “This may include calculating the effect of using the proposed mortality tables to value their pension liabilities, and conducting a mortality experience study for their plans. Sponsors may also wish to explore available options to mitigate the long-term risk posed by increasing life expectancy.”
Impact on Capital Accumulation and Defined Contribution Pension Plans
The implications of lengthening lifespan are not limited to sponsors of DB pension plans. Employers sponsoring defined contribution (DC) and other types of capital accumulation plans should also take note. In a DC plan, the employer provides a fixed contribution to a pension plan over the career of the employee. The plan member is required to manage the investments and ultimate pot of money from which to draw retirement funds or to purchase an annuity for their lifetime.
“Increasing life expectancy could mean that employees with a DC or capital accumulation plan will need to save more in order to afford retirement”, said Michelle Loder, Towers Watson’s Canadian DC Leader. “This could result in employees delaying their retirement until they have accumulated sufficient retirement savings, possibly challenging employers’ ability to manage career progression and workforce objectives.”
To better adapt to changing workforce demographics, DC plan sponsors may want to consider evaluating how prepared their workforce is for a financially fit retirement and to establish goals for improving this measure. As Loder said, “the increase in life expectancy can serve as a reminder of the need to educate employees and provide them with decision support tools to help them understand the risk of outliving their pension savings, and the options and actions they can take to manage this risk.”
Public Versus Private Sector Lifespans
In a potential twist for public sector plan sponsors, the study also finds generally higher overall life expectancy for workers in the public sector compared to the private sector. “While this may be good news for public sector employees and pensioners who are largely covered by DB plans, there will be financial implications to consider. However, policy makers will need to balance those considerations against the effective recruitment and retention benefits that DB pensions can provide,” concluded Benjamin.
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