The Office of National Statistics reports stagnant life expectancy rates across the UK, including a reduction in three countries (Northern Ireland, Scotland and Wales). While such statistics cause little concern for most people, on the basis that this is a ‘distant future’ matter, employee benefit nerds like me are joining the dots with the trending adjustment factor in retirement ages: life expectancy.
Social security systems are traditionally based on the pay-as-you-go (PAYG) funding model. PAYG requires that current contributions (inputs) sufficiently fulfil current pension payment obligations (outputs); any misalignment creates a fiscal gap.
Let us consider the link between life expectancy, normal retirement age and the sustainability of social security systems. Striking a balance between the working life (e.g. contributions until reaching normal retirement age) and the period of retirement (e.g. pension payments until death - life expectancy) is critical to the funding of state benefits (long-term sustainability).
The BBC reports (BBC, 2018) that Netherlands and Japan, among others, are outperforming the UK in terms of life expectancy. The country snapshots below demonstrate how the three factors interact in different scenarios:
Should current trends continue, longer retirement periods would be a reasonable expectation in Japan and the Netherlands. Resulting fiscal pressures are countered by the life expectancy factor in the Netherlands; Japan has no such systemic tool. Resiliency is otherwise fostered in the Netherlands through promulgated retirement age increases, which deliver additional inputs and delay some outputs.
Remedial action is also underway in the UK. While the normal retirement age rise in the Netherlands ends in 2022 after one tranche (the switch to a life expectancy linked formula), multiple tranches of rises are enshrined in UK legislation with the first already boosting inputs by extending work lives. Like in Japan, there are no automatic adjustments linking life expectancy and retirement ages. However, unlike in Japan, life expectancy is reducing in three of four UK countries – which may bring future funding pressure relief.
Formulae linking life expectancy and retirement ages typically permit a retirement age increase up to a prescribed limit and at a prescribed time. Which leaves a question of how to deal with at least one relatively untested combination of scenarios: a life expectancy-normal retirement age link (per the Netherlands) plus a shrinking life expectancy (per Northern Ireland, Wales and Scotland)?
The dramatic increase in average life expectancy during the 20th century ranks as one of society’s greatest achievements