Retirement income: why we need to focus on the longevity tail

The latest paper from the Thinking Ahead Institute’s working group on defined contribution is now available for members. Focusing on the topical question of lifetime retirement income, the paper argues that the unsolved part of the puzzle is the longevity tail: how do you protect against the risk of living an unexpectedly long life? Isolating this part of the puzzle opens up a path to a wider range of solutions.

Typically, average life expectancy at the point of retirement is around 20-25 years. But that’s just the average. Some retirees are fortunate enough to have a retirement lasting 30, 40 or even 50 years. This longevity tail is the reason that lifetime retirement income is proving such a tricky problem to solve in practice. Investment-based solutions alone cannot deal with an uncertain tail: a very long life is a low-probability-high-impact risk, which is the type of situation where the case for insurance is strongest.

The only strategy being widely used to insure the longevity tail at present is the traditional immediate annuity. But annuities don’t just cover the longevity tail, they cover the whole of the retirement period, which means they tie up a much bigger portion of a retiree’s assets. They’re a good solution for some, but have not proved to have broad appeal. Other insurance solutions – focused more narrowly on the tail – are needed.

Isolating the longevity tail allows solutions to be developed that complement, rather than compete with, existing investment-based drawdown strategies. The primary drawdown phase – the period covering typical life expectancy – is already a well-served and generally competitive marketplace. A longevity tail insurance solution can also take care of the primary drawdown phase (and traditional annuities, for example, do) but it doesn’t have to. There’s no good reason that a wider range of approaches shouldn’t be available to retirees.

The paper acknowledges the many hurdles to overcome for this to become reality, and for the right role to be found for longevity tail insurance in default options and the wider choice architecture. There are real challenges related to both demand and supply that will need to be addressed, as well as other questions such as potential fiduciary liability to be considered.

In reality, a safe harbour or other targeted regulatory intervention of some sort could well be needed to act as a catalyst and to spur both demand for, and supply of, longevity tail insurance. Such a move would shape plan design, provide an endorsement for action, and redefine perceived norms.

The question of lifetime retirement income is becoming increasingly prominent across all the world’s major DC markets. Finding the right solution begins with recognising where the unsolved part of the puzzle lies: it’s the longevity tail we need to focus on.