## Insurance or right?

The Economist recently carried an article about the perceived unfairness of increasing the retirement age. The argument is that poorer people have higher mortality rates, which means they get less value from a given pension than richer people: the poor are less likely to survive long enough to receive the pension, and if they do they will draw it for a shorter period of time. Of course, a similar argument applies to males or smokers: they have higher mortality rates than females and non-smokers, respectively.

At the root of this problem is the little-discussed question of whether an old-age pension is an insurance or a benefit of right. When the first UK-wide state pension commenced in 1909, a twenty-year-old male had a 34.8% chance of surviving to the then-pension age of 70. Once retired, a seventy-year-old male had a life expectancy of 8.0 years[1]. The original state pension in the UK therefore had the hallmarks of a social-insurance system — the probability of surviving to receive the pension was relatively modest. The system as constructed was affordable not just because survival probabilities were low and life expectancy was short, but also because benefits were means-tested.

A century later, a twenty-year-old UK male now has a 79.0% chance of living to age 70. Once retired, a seventy-year-old male now has a life expectancy of 14.2 years[2]. A pension system based on these rates looks a lot less like social insurance — the probability of surviving to receive the pension is more double that of a century ago and most people can now expect to reach the qualifying age. In fact, the system is even less affordable than it looks because the actual State Pension Age is younger than age 70; for many people — including the author — it is currently 67. The survival probability from age 20 to age 67 is 83.6%, and the life expectancy from age 67 is 16.3 years, i.e. double the life expectancy under the original system.

We can see how the debate about the fairness of the retirement age has arisen. The basic state pension was conceived and set up as a social-insurance safety net, as only just over a third of adult males were expected to survive to the retirement age. Over time, however, the dramatic fall in mortality rates has changed the perception of retirement to something one will very likely reach. As a result, this has also changed the perception of retirement pensions. The problem is that the costs have increased radically: to fund the original social-insurance pension, a relatively modest amount needs to be taken from everyone to fund pensions for a smallish proportion of survivors. In contrast, funding the current system demands that a much larger amount needs to be taken from everyone to pay pensions for a large proportion of survivors who also live a lot longer than before.

This then raises a question: what would the state pension age have to be to restore the eight-year life expectancy of the original Old-Age Pension Act of 1908? The answer is 80 years old, and a twenty-year-old male would have a better than evens chance (54.5%) of reaching that age[2].

References

[1] Period survival probability and period life expectancy calculated according to ELT 6 Construction A in King (1909). No allowance for mortality improvements.

[2] Period survival probability and period life expectancy calculated according to the Interim Life Table for the UK for 2008–2010. No allowance for mortality improvements.

King, G. (1909) On a New Method of Constructing and of Graduating Mortality and other Tables, Journal of the Institute of Actuaries, XLIII, p150.

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