EUROPEAN PAPERS ON THE NEW WELFARE

Technological Changes, the Reversal of Age Pyramids and the Future of Retirement Systems

During the industrialisation process, the interaction between the forces of fast declining mortality and slowly declining birth rates will be responsible for remarkable changes in the size of populations, as shown in the projection below, bringing some countries into the group of the top largest in the world. The countries just joining the industrialisation process will accelerate their population growth, while other countries will be affected by the declining birth rates and will experience a slow growth and in some cases even a reduction of their population. The ranking of countries by size exhibits dramatic changes in the first half of the twenty first century, changes that will cause major changes in world politics and economics, and will determine major trends in retirement .

Table 1: Largest countries by Population 2005-2050

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Source: U.S. Census Bureau, International database.

The changing pattern of the population pyramids means that about 60-70 years after the industrial revolution, the ‘baby boom’ turns into a ‘geriatric boom’. The proportion of the older population increases, but due to the baby boom, the absolute number of old people demonstrates a very sharp increase during the 60-70 year period. The diagrams for Brazil demonstrate this point. In 2000 there were about one million females in the 80+ age group. The number is expected to grow to about nine million in 2050, while the population is expected to increase by only 22% (from 186 to 228 million).
The population structure is often translated into ‘dependency ratios’, that is, the ratios of dependants (children and people beyond working age) to the number of people in the working age group. These ratios are quite stable over time, despite the drastically changing population structure (people in the working age groups are typically between half to two thirds of the population — as seen in the U.S. diagram below). In agricultural countries the number of children is large, but the number of old people is small. Dependency ratios tend to be around 75-100%. Countries in the middle of industrialisation tend to have even lower dependency ratios (around 50% and sometimes even less). This is the result of complex trends: the birth rate and number of children has already declined, the number of old people has not yet increased substantially, and the baby boomers are already working adults.
The ratio between the older people and the young ones is a more sensitive measure of the developmental stage. It changes drastically: the ratio of people aged 65+ to children below five, for example could be 3.5-4.0 in post-industrial countries, as compared to only 0.3-0.5 in the least developed countries. This ratio gives a better idea of the future retirement problems: since most children are expected to survive until retirement, it shows how many retired people will have to be supported by one person in the working age groups. (As one of my colleagues has pointed out: in China one child will soon have to take care of two parents, four grandparents and, and eight great grandparents…).

Figure 12: Dependency ratios diagrams
Percentage of population in 4 ages groups: united States, 1950, 200 and 2050
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Source: Center for Disease Control and Prevention, National Center for Health Statistics. Health, United States, 2004

4. Mortality and the Longevity Risk

The above changes in population pyramids and dependency ratios are accompanied and augmented by the increasing life expectancy, which is the immediate result of the sharp reduction in mortality rates. During the last century the developed countries have experienced an unprecedented increase in longevity, one that has never before been experienced! At the beginning of the twentieth century life expectancy around birth (corrected for mortality in the first few months after birth) was around 45-50 years in most currently developed countries. A century later, at the beginning of the twenty-first century, life expectancy is around 76 years for males and approximately 80 years for females. In other words, life expectancy at birth has increased on the average by one year for every 3-4 calendar years! The following figures show the changes that took place in the U.S.A. during the twentieth century. In 1900-2 the life expectancy of white males and females in the U.S.A. was 48.2 and 51.1, respectively. The parallel figures in 2002 are 75.1 and 80.3, respectively.
In a cross-section analysis, the WHO statistics show that life expectancy for the entire population (males and females) is below 60 for pre-industrial countries (in some countries it could even be as low as 40!). On the other hand, post-industrial countries experience life expectancy figures around 77-82 (for the entire population). Life expectancy increases mainly due to developments in health, nutrition and hygiene, but will it continue to increase at the same rate in the future? Is there a limit to the human life span? These are critical questions for retirement planning.
Scientists cannot give us a definite answer yet. Some claim that the body cells are designed to last only for a certain period (for example, heart cells are assumed to have a limited number of beats), others believe that we are on the verge of deciphering the mechanism that determines the ageing of cells, and we will learn the way to control it. Meanwhile we experience a continuous increase in life expectancy due to the cumulative effect of gradual improvements in a wide variety of medical technologies. Medicine knows how to replace some failing systems through transplants, how to open clogged arteries, how to administer all kinds of drugs in order to fight many diseases.
About half of all deaths of adult males and about a quarter of all deaths of adult females are due to cardio-vascular diseases, hypertension and renal diseases. Another quarter of all deaths of adult males and about half of all deaths of adult females are related to cancer. In other words, about three quarters of the deaths of the adult population are related to these two major groups of sickness. Major breakthroughs in these areas may lead to a remarkable decline of death rates, and this may lead to a further substantial increase in life expectancy (a reduction of mortality probabilities in all age groups by half can increase life expectancy at birth by about five years).
Important advances in medicine are expected in the future due to the improved knowledge and understanding of genetics and complex biochemical processes, better screening devices, smarter surgical technologies, improved medical care (and maybe even due to improved understanding of the balance between body and spirit). All these will affect a variety of medical areas such as cancer, heart diseases, diabetes, strokes, neurology and gerontology, metabolic diseases, etc. Certain factors may interfere, delay and even stop the development. Among these could be economic and financial forces, global epidemics of new diseases, contamination and pollution, and political factors (wars, nuclear disasters).
Human society is the only one among all animals that values longevity as a target. It is not improbable that this value will be challenged in the future, and that societies finding it difficult to cope with the soaring costs of retirement and of health-related costs will put all kinds of constraints on medical treatment to aged people. This involves ethical problems that go beyond the scope of this essay.

4.1 Demography and the Basics of a Retirement System

Longevity is probably one of the most important risks that affect our economies. Planners of retirement systems typically focus on the economic and financial aspects and often ignore the basic demographic considerations. As the following model shows, the drastic changes in mortality and life expectancies should not be ignored.
Assume a very basic model, where people join the labour forces at the age of 20, and retire at the age of 65. In addition assume that life expectancy is 75, and is not expected to change, and that the interest rate can be ignored. Assume also that the annual consumption of a retired person is similar to that of a working person (quite a realistic assumption in view of studies showing that the total consumption is quite stable, though its composition changes significantly with age). These basic parameters seem to generate a simple retirement model: during 45 years of work, people are supposed to accumulate sufficient funds to cover an additional 10 years, that is, put aside about 10/45 of their annual income.
There are two major flaws in this basic model, and both of them stem from a misinterpretation of the concept of life expectancy. First, relying on an average number (life expectancy) may be fine for a financial institution that holds a large portfolio of many insured people. An individual, however, is not supposed to plan her insurance needs according to average figures, but must prepare for the extreme cases. Life expectancy is an average figure. A high proportion of the retired people will live by far longer than the assumed life expectancy (age 75). What will all these people do when the funds are depleted at the end of the assumed 10-year post-retirement period?
Secondly, when people refer to life expectancy, they commonly refer to the published figure, which is life expectancy at birth (i.e., the average age of death). The remaining life expectancy is a complicated function of age. If life expectancy at birth is 75, the remaining life expectancy at the age of 65 may be substantially higher than 10 years (75 minus 65), insofar as those who reach age 65 have survived the childhood diseases, the motorcycle accidents, maybe the risks of a military service, etc. The U.S. Vital Statistics, for example, show that the life expectancy at birth of white males in 2002 is 75.1 (Center of Disease Control, 2004). The remaining (conditional) life expectancy at 65 is not just 10.1 years, but rather 18.2 years!
The above figures mean that when the U.S. white male in our model reaches retirement he had better have sufficient funds for 18.2 years, on the average, rather than just 10 years as the model has assumed (and this figure is subject to the first comment about the use of averages in personal planning). Putting aside savings for 18.2 years over 45 years of assumed employment is almost double the naïve calculation that assumed a 10/45 ratio!
The problem of females is even more pressing in practice. Females are the biological stronger gender, and their life expectancy at birth is typically longer than that of males. In 2002, for example, life expectancy at birth for white American females was 80.3 (as compared to only 75.1 for males). However, females tend to retire earlier, say at the age of 60, and the remaining life expectancy at that age is 23.6. Earlier retirement, however, also means a shorter working period. Say only 40 years in our model (60 minus 20). Moreover, traditionally many women often spend a few years out of the wage-earning labour force in order to raise the family. So the average working period for women can be reduced to 30 years or less. One needs to be a financial magician to be able to accumulate enough savings to finance a post-retirement period of 23.6 years over approximately 30 years of work!


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