IMF: World sitting on ageing 'time bomb'

Most people likely to live 3 years longer than expected, so costs of ageing set to balloon

By Ann Williams, The Straits Times, 19 Apr 2012

FIRST, the good news: We will live longer than we expect. The bad news: We won't be able to afford it.

The International Monetary Fund (IMF) warns in a study that most people are likely to live three years longer than anticipated - and that mere three years could double the costs of ageing by 2050.

Richer countries would have to set aside another 50 per cent of their 2010 gross domestic product (GDP) and developing nations, an extra 25 per cent.

Although the IMF study does not have figures for Singapore, which has the world's third-fastest ageing population, it is not likely to be spared.

The study, from the IMF's Global Financial Stability Report, April 2012 released yesterday, is the latest in a series of analyses warning of the potentially huge costs of ageing. What makes it worth closer scrutiny is the IMF's argument that planners typically underestimate longevity by three years on average. This mistake could cost the global economy tens of trillions more dollars in pension costs alone, says IMF.

The systematic and widespread underestimation of life expectancy came about because planners, basing their models more on historical information, assumed that the current rates of improvement in life expectancy would slow down. In reality, they have not, partly because of medical advances, such as better treatments for cancer and HIV/Aids, and because of changes in human behaviour.

In Singapore, the proportion of residents aged 65 and above increased from 7.2 per cent in 2000 to 9.3 per cent last year. By 2030, this will hit 19 per cent.

If someone retires at 65 today and plans his retirement finances expecting to live another 20 years, he would face a serious personal financial crisis if he actually lives just three years longer.

Take this so-called 'longevity risk' and multiply it several billion times and one gets the extent of the global problem.

A large part of the extra costs could fall on governments, many already struggling with huge budget deficits.

In the United States, the issue is a major topic in the election fight over control of Congress and the White House. If the IMF is right, and the US is underestimating the life expectancy of its population by three years, that would mean a US$7 trillion (S$8.8 trillion) error in calculating future costs over the next 40 years - or roughly US$175 billion a year.

The US debt problem could potentially be far worse than thought. Already last year, the US lost its top credit rating over concerns about the ability of the government to rein in its debt, sending shock waves through global financial markets.

Still, the IMF estimated that the risk is worst in Japan, which has the fastest-ageing population in the world. If the Japanese live three years longer than expected, it would cost the nation an extra 87 per cent of its 2010 GDP by 2050.

Germany is in second place, with a potential additional cost of 74 per cent; Britain could face a bill worth 59 per cent of 2010 GDP, while the US could be hit with costs equivalent to 52 per cent.

If these rates continue till 2050, the debt-to-GDP ratios could rise to 300 per cent for Japan, 150 per cent for Germany and the US, and 130 per cent for Britain.

'These costs are high enough that they can't be absorbed by any one sector,' said Ms Laura Kodres, a senior author of the IMF report. 'That risk has to be acknowledged, it has to be assessed, and then it has to be shared.'

One way to share the risk is to have individuals work longer by raising the retirement age. The extra income would also generate additional tax revenue, offsetting some costs. Another is to cut benefits such as state pensions, but this would be 'perhaps most difficult politically'.

A third way is to transfer some of the financial risk to the capital markets. The IMF cites how pension funds in Britain and the Netherlands have transferred their risk to banks and insurers for a fee.

However, just as these so-called longevity swaps have taken off, they are at least partially threatened by tightening financial regulation, said the IMF.

In the past six months, investment banks UBS and Credit Suisse have both pulled out of arranging longevity trades thanks to stricter capital requirements under Basel III, the latest set of international standards for banks.