The impact of longevity on the insurance business
An interview with Odette Cesari
AXA IM: Has rising longevity increased uncertainty around mortality tables? If so, how does it affect insurance companies?
People usually discuss life expectancy from birth, but what matters most when it comes to the world of pensions is actually life expectancy from 65 years onwards. Historically, longevity gains were first achieved thanks to the drop in infant mortality. Today, however, these life expectancy gains are increasingly coming at the end of life. (Exhibit 1). And, as life expectancy in retirement is increasing more than overall life expectancy, so insurers face a rising longevity risk – the risk that they will have to pay out retirement products for longer than originally intended...
Today, our best estimates remain our regulatory tables, namely life tables, but there is of course an awareness that lifespans are increasing, and with them the possibility that these estimates will need to be changed. Faced with this increased risk, we have carried out reinsurance transactions in order to protect ourselves including the purchase of swaps, in an effort to hedge this risk. We also use proprietary models, validated both internally and by the French Prudential Supervision and Resolution Authority, which allows us to test the impact of various longevity-related shocks. This scenario modelling has led us to build up a precautionary capital buffer to address a potential longevity shock.
How aware are our customers of longevity risk? And, do you expect this to change?
If we take the point of view of the average French employee, the level of awareness of longevity risk is almost non-existent. In fact, the majority of people exhibit a rather contradictory approach: they live as if they are never going to die, but they do not save for such a scenario. In fact, they tend to do the opposite. For example, when going into retirement, each person has to cash in their pension rights after which they are faced with a choice between receiving an annuity and taking the capital as a lump sum. Many people are attracted to the lump sum, which often looks like a substantial amount of money. And, once they have that money in their hands, it proves very difficult to invest this money properly and be protected all life long. But, such a choice is completely at odds with the collective worry of living for longer. I believe part of the reason for this is that many within France still have strong memories of the high inflation seen during the 1970s and 1980s and are worried that such a scenario could reoccur. Some people also don’t want to ‘lose out’ if they die prematurely and thus do not get back a sufficient amount of ‘their’ money.
This ambiguous approach to longevity is one of the factors that limit [complementary] retirement savings because 1/ there’s a general unwillingness to save for retirement and 2/ a large share of the existing savings come out in capital. Hopefully the new “Loi Pacte” law will offer an opportunity to increase the level of understanding and consider investing for the long term.
Having assimilated all these risks, how are you approaching the future from a modelling perspective?
First of all, it is important to remember that the pension plan is closely linked to three main risks: disability, work accidents and death. For example, if the retirement age is increased by two years, say from 63 to 65, the probability that there will be an event triggering compensation (in capital or as a pension) increases during these additional two years. But that is not all, while this frequency effect is important, it is exacerbated by a duration effect, as this state of disability tends to be longer as well. As a result, the insurer must then take over the insured until the new maturity age. All this leads to a change in the balance between pension and protection on the pension and potentially higher costs for the company, the employee and the insurer.
In your private retirement fund panel do you offer the ability to insure longevity risk?
Yes,paying an annuity provides such an offer. When we take a pension contract, the balance between salary increase and pension plan contributions is a topic for negotiation between unions and the company. In many cases, this is part of the the annual negotiation about wages and benefits,. If in the negotiations, the unions are convinced that it is necessary to increase the pension contribution by 0.5% instead of increasing wages by 0.5%, this expenditure will enter into the cost of labour and will therefore be covered by the company in all cases It will result in higher liabilities for the insurance company in most cases.
The French Mandatory Insurance system seems to have a unique approach to longevity risk. Would you agree?
To begin with, there is definitely a regulatory effect. We regularly get the same answers and feedback from the field interviews we organise every other year on the streets. Some people expect a replacement rate still at 90%, which is quite far from the reality (Exhibit 2), and therefore do not feel concerned with the longevity risk, some others conversely think that they will never get anything in terms of pension rights… and they still do nothing about it [in terms of complementary savings], which is quite contradictory.
The results are very different elsewhere. For example, Anglo Saxons interviewed were all quite sensitive to the issue of retirement savings and explained how they resorted to private savings plans, regardless of their age really. Of course, one should nuance this analysis: French employees can rely on the public Social Security system for their pension whereas some other countries do not necessarily have the same level of public coverage. This may explain the lack of awareness in France: whatever they say, French people do expect the public welfare system to provide for them.
Can we hope for more longevity awareness in France with better pension information?
The tools available have made tremendous progress. For example, there is today a state-run website lassuranceretraite, which aims at gathering information and simplifying the forecast on one’s retirement entitlement. It's very simple to access, all you need is your social security number; you create an account and get direct access to your entire career. Of course, the projections may not be fully accurate, especially if you are young and there will be some assumptions to make; but overall we find that it provides an accurate estimate of your pension rights with the mandatory scheme by aggregating the Social Security base with all public supplementary pensions. The Loi Pacte will make it possible to standardise all this, to have a global view of what we have in retirement savings beyond the public schemes.AXA is providing its clients with a tool that aggregates all its private individual and collective contributions. And, in that way makes it easier to understand where they stand and what they still need if they are to have the tomorrow they want.