Addressing the life expectancy gap in pension policy

Abstract

Understanding the systematic relationship between period and cohort life expectancy and how the relationship evolves over time are critical issues in formulating the design of retirement income products, evaluating the actuarial balance of pension schemes, and more generally for all analyses where demographic projections are involved. In this study, estimates of the life expectancy gap at all ages are performed using data for 1960-2018 from the Human Mortality Database and projections are generated through 2050 for the 42 national populations, disaggregated by sex. Contrary to previous research that often uses a single deemed to be «best» model to forecast mortality rates, we use a novel adaptive Bayesian Model Ensemble of heterogeneous parametric generalized age-period-cohort stochastic mortality models, principal component methods, and smoothing approaches. The procedure involves both the selection of the model confidence set and the determination of optimal weights. Model-averaged Bayesian credible prediction intervals are derived accounting for both the uncertainty arising from model error and parameter uncertainty. With intergenerational actuarial fairness and neutrality as the guiding principles the study then explores potential policy interventions to address the consequences of the life expectancy gap - spanning over adjustments in the accumulation, benefit determination, and payout stages. Comprehensive numerical results are provided for two policy options: (i) introducing a sustainability factor; and (ii) conditional pension indexation. The results show that: (i) the life expectancy gap is positive and significant for almost all countries and years studied, (ii) it will continue to increase, (iii) the magnitude of the subsidy rates between generations can be sizeable demanding important initial pension benefit reduction and/or a gradual diminution in the annual indexation rate of pensions to correct them.