Intergenerational actuarial fairness when longevity increases: Amending the retirement age

Abstract

Continuous longevity improvements and population ageing have led countries to modify national public pension schemes by increasing standard and early retirement ages in a discretionary, scheduled, or automatic way, and making it harder for people to retire prematurely. To this end, countries have adopted alternative retirement age strategies, but our analyses show that the measures taken are often poorly designed and consequently misaligned with the pension scheme's ultimate goals. This paper discusses how to implement automatic indexation of the retirement age to life expectancy developments while respecting the principles of intergenerational actuarial fairness and neutrality among generations of the respective policy scheme design. With stable demographic conditions, we show in policy designs in which extended working lives translate into additional pension entitlements, the pension age must be automatically updated to keep the period in retirement constant. Alternatively, policy designs that pursue a fixed replacement rate are consistent with retirement age policies targeting a constant balance between active years in the workforce and years in retirement. Under conditions of population ageing, the statutory pension age will have to increase at a faster rate to meet the intergenerational equity criteria. The empirical strategy employed a Bayesian Model Ensemble approach to stochastic mortality modelling to address model risk and generate forecasts of intergenerationally and actuarially fair pension ages for 23 countries from 2000 to 2050. The findings show that the pension age increases needed to accommodate the effect of longevity developments on pay-as-you-go equilibrium and to reinstate equity between generations are sizeable and well beyond those employed and/or legislated in most countries. A new wave of pension reforms may be at the doorsteps.