Australia's Future Tax System

Retirement Income Strategic Issues Paper

7. Insuring against longevity risk

7.1 Recommendation

Longevity insurance should form part of a suite of options available to people to insure against the risk they will outlive their assets in retirement.

In its final report, the Panel will give further consideration to the type of products and the appropriate role of the government in assisting with the development of these products.

7.2 Discussion

Australians have one of the longest life expectancies in the world. Advances in health technologies are likely to result in each generation living longer than the preceding generation. On current trends, men aged 60 years in 2047 are projected to live an average of 5.1 years longer than those aged 60 years in 2007 and women an average of 4.7 years longer (Australian Government 2007).

Life expectancies refer only to averages. The numbers of people living longer than average life expectancy is growing very rapidly and will continue to do so.

Thus there are two types of longevity risk. First, for the whole population, there is the risk that average life expectancies will increase. Second, for each individual, there is the risk that their life will extend into late age beyond average expectancy.

The length of a person's life will have a significant influence on how long they can potentially sustain income above the Age Pension through use of their superannuation and other savings. The Age Pension already incorporates a full longevity risk insurance feature — it is paid for as long as an eligible pensioner lives (and no longer). However, few people have superannuation products which meet the same longevity risk needs.

Longevity insurance

Some submissions suggest individuals be required to use their superannuation to purchase a retirement income stream and/or that restrictions be imposed on access to lump sums. There is concern that flexibility in the use of superannuation may detract from the objective of promoting higher retirement incomes.

However, this flexibility enables people to make decisions in their best interests and is likely to result in outcomes largely consistent with the broader objective of promoting retirement saving.

The uncertainty about when a person will die makes managing their assets to last over their lifetime very difficult. The market in Australia for products that provide either a lifetime, or deferred income stream is not as developed as in some other countries.

Issues

In developing proposals relating to longevity insurance, it will be necessary to consider whether (or to what extent) the insurance:

  • is mandatory or voluntary;
  • provides guaranteed or non-guaranteed income; and
  • is provided by the public or private sector.

Mandatory or voluntary

Under a mandatory scheme, people would invest a proportion of their superannuation (whether during the contribution process or at a later point from accumulated balances) into a pool, from which an income would be paid from a nominated age.

The introduction of a mandatory scheme for accumulated balances may be difficult to implement in the short to medium term for a number of reasons. Superannuation balances are unlikely to support significant income streams for many years, as the compulsory system is still maturing. Even when the system is mature, many people will not have a full working life of compulsory saving due to periods outside the workforce and others, such as migrants, entering the system at a later age.

In a mandatory scheme, people who die before or shortly after the age at which the annuity commences support the income of those who live longer. Consequently, there are potential equity issues, especially for groups in the community who tend to have lower life expectancies, such as low income earners and Indigenous Australians.

A voluntary system would mean a person can insure as much of the risk as they wish. However, the pool would not be as large as under a mandatory system. This would place more risk on the provider, as the people choosing to insure are more likely to be those who consider they have a good chance of living beyond average life expectancies. The provider would pass on this risk by offering a lower income than might be payable under a mandatory scheme. This is particularly the case where the income is guaranteed.

Guaranteed or non-guaranteed products

The provision of a guaranteed income, while providing greater certainty for retirees, would present several challenges. For example, providers would need to satisfy the capital requirements set by the Australian Prudential Regulation Authority (in respect of reserve and matching requirements), which could increase the cost of the product. Providers would also need to price expected mortality improvements into the products, which would be challenging to predict accurately. Given these challenges, it is likely that the products in the private sector could be offered only by life insurance companies.

With a non-guaranteed product, a person does not purchase a right to an income but a right to a distribution from a pool of assets. This moves the investment and mortality risk from the provider to the individual. These assets have similar risk characteristics to those applying in the accumulation phase, with the exception that investment returns are supported by deaths of the members within the pool.

Private versus public provision

Private entities, such as life insurance companies, can already provide products that insure an income over a person's life. Depending on the product, other entities may also be able to enter this market.

The government is already the main provider of longevity insurance through the Age Pension. This may provide the infrastructure to enable a person to purchase an additional guaranteed income. The government may also be able to offset the risks inherent in offering an income guarantee more effectively than the private sector, especially if the government has to insure private sector guarantees.