The Chinese Pension System
February 12, 2025
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Advances in medical science have increased the life span of individuals. It is now common for people to live for ten to twenty years longer than their previous generation. This seems like a good development from a humanist point of view. However, from a pension fund’s point of view, a longer life span has several financial implications. These financial implications are called “longevity risk”. In this article, we will have a closer look at the impact of longevity risk on pension funds.
Pension funds sell annuities of uncertain tenure to their beneficiaries. The tenure for which the monthly payment will continue depends upon the longevity of the beneficiary. If more beneficiaries start surviving for a longer period of time, there can be a significant financial impact on the fund.
Changes in the medical field lead to a change in this data every year. However, a lot of the time, pension funds do not account for these changes. Hence, money is invested based on assumptions that are very different as compared to the final outcome.
Hence, the pension funds can start adjusting their financial plans which would allow them to make these payments at a later date. At the same time, if the mean age of the pension fund is high i.e. most of the beneficiaries are old, the pay-out might not be affected so much. However, the fund has very little time to make adjustments in order to provide for this increased cash flow.
It has been estimated that a two-percentage-point fall in the interest rate leads to a 20% increase in the liabilities of the pension fund. Since lower interest rates have now become the norm across the developed world, pension funds are feeling a greater impact of the longevity risk.
Pension funds have created another method that is more useful in managing their financial position. Pension funds have started indexing the value of their pay-outs with the average life expectancy. This solution allows pension funds to manage their finances without using discriminatory policies.
The bottom line is that longevity risk is unique to the pension fund industry. However, it can have a massive impact on the financials of any fund. Also, with medical science advancing by the day, life expectancy is expected to continue to rise in the future. Hence, it is very important for pension funds to recognize longevity risks and also take steps to properly manage the same.
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