Pensions continue to underestimate longevity risk: Bank of America

The world’s pension and retirement systems continue to underestimate the scale of the longevity risk they face, as populations continue to grow and age, with estimates suggesting annuity and pension longevity exposures could reach $25 trillion by 2050.

Bank of America Merrill Lynch analyst Sarbjit Nahal discusses the increasing threat to the global retirement and pension system in a report looking at thematic investing from the bank. While the report advises on areas to capitalise on the aging population, by investing selectively in stocks which stand to benefit from longevity risk, it highlights the growing exposure the pension system faces.

“Global aging is one of the greatest social and economic transformations of the 21st century, with aging having become an almost universal phenomenon. The number of persons aged 60+ is expected to more than double to 2 billion by 2050, when the number of seniors will also outnumber children under 5 for the first time in human history,” explains Nahal.

With every increase in age expectations, pensions potential shortfalls due to longevity exposure grow. The requirement to hedge these longevity risks is set to increase and with ample capacity currently available for pension plans looking to offload longevity risks this market is expected to boom in the coming years.

“Longevity risk will be one of the most significant challenges facing retirement systems over the next 50 years, with global annuity and pension related exposures estimated to be as high as US$15-25 trillion, including $7 trillion sitting in U.S. defined benefit plans alone,” Nahal warned.

The costs associated with longevity risk to the retirement system are potentially enormous, which puts this risk outside of the capabilities of the reinsurance market alone to deal with assuming longevity risks. Bank of America Merrill Lynch highlights that the IMF says that some countries could face additional costs of up to 50% of their 2010 GDP by 2050 as this longevity exposure continues to grow.

Effectively hedging, transferring and reinsuring this huge amount of longevity exposure will require capital markets support and the expectation remains that once a way is found to transfer longevity risk to capital markets investors, with liquidity and transferability, a capital market in longevity risk will be established.

The report highlights the fact that longevity exposure continues to grow and so far the world has found no way to slow this steady growth in exposure. Longevity risk is at a point where risk transfer is perhaps the only solution, as pensions and retirement systems are increasingly getting to the point where changes in investment strategy will not offset the increasing demands of an aging pension population.

Check out our list of major longevity swaps, risk transfers and reinsurance transactions here.