April 14, 2012

Systemic Underestimation of future life expectancy by 3 years for every 20 years

Conversable Economist - What if retirement programs are underestimating how much longevity is likely to rise? The April 2012 Global Financial Stability report from the IMF tackles this question in Chapter 4: "The Financial Impact of Longevity Risk."

The main source of longevity risk is therefore the discrepancy between actual and expected lifespans, which has been large and one-sided: forecasters, regardless of the techniques they use, have consistently underestimated how long people will live. These forecast errors have been systematic over time and across populations. ... In fact, underestimation is widespread across countries: 20-year forecasts of longevity made in recent decades in Australia, Canada, Japan, New Zealand, and the United States have been too low by an average of 3 years. The systematic errors appear to arise from the assumption that currently observed rates of longevity improvement would slow down in the future. In reality, they have not slowed down, partly because medical advances, such as better treatments for cancer and HIV-AIDS, have continued to raise life expectancy.

If everyone in 2050 lived just three years longer than now expected—in line with the average underestimation
of longevity in the past—society would need extra resources equal to 1 to 2 percent of GDP per year. If this longevity shock occurred today and society wanted to save to pay for these extra resources for the next 40 years (that is, fully fund these additional “pension liabilities”), advanced economies would have to set aside about 50 percent of 2010 GDP, and emerging economies would need about 25 percent of 2010 GDP—a sum totaling tens of trillions of dollars. As such, longevity risk potentially adds one-half to the vast costs of aging up to the year 2050—and aging costs themselves are not fully recognized in most long-term fiscal plans.

Kevin Murphy and Robert Topel estimated in a 2006 paper in the Journal of Political Economy ("The Value of Health and Longevity," 114:5, pp. 871-904) that the 30 years of additional life expectancy gained by an average American during the 20th century was $1.3 million per person.

So increasing life spans is an economic good and we just have to increase retirement ages or change retirement programs to be able to adjust to lifespan increases.

If you liked this article, please give it a quick review on ycombinator or StumbleUpon. Thanks
blog comments powered by Disqus