Longer life expectancies affect both DB and DC pension plan holders

The Canadian Institute of Actuaries (CIA) recently modified their pensioner mortality tables to reflect the longer lives of Canadians (see chart below).

The update enables pension plan sponsors to better calculate their financial promises to those eligible to receive a pension (or a survivor’s benefit).  Companies with defined-benefit pension (DB) plans, which are guaranteed to their members, need to assess if funding modifications are needed based on these new longevity assumptions to ensure they can meet their pension promises.

Defined-benefit pension plans and your health

Let me be brutally honest on this one…the DB pension plan only cares if you are alive or dead. No other pension plan needs to consider your life expectancy because you hold all the risk—more on this later. Even so, with DB plans there are two degrees of being dead—survivor benefits or none. Your health is not an issue for a DB plan. Regardless of your level of health, the DB plan pays out its obligation. Once you die the obligation may cease if there is no survivor benefit (e.g. it was not needed by you or you opted out), or the obligation continues at a lesser amount for the surviving spouse.

A longer life expectancy does not necessarily mean more healthy years. The pension mortality tables do not need to reflect this reality since defined-benefit payouts happen regardless of your health. However, you need still need to consider the costs and other issues that arise when health deteriorates. Statistics Canada estimates average life expectancy as well as average health-adjusted life-expectancy (see chart below). The difference between the two measures is in the quality of the years that are lived. The data indicate that a male will experience 9.4 years on average of poor quality life. For females it is 11.8 years on average of life with disability. Accompanying these years may be additional costs for special care services, potential relocation, medications and other medical aids.

Other pension plans such as defined-contribution

Defined-contribution (DC) pensioners (and group RRSP, hybrid plans) hold 100% of the pension risk.  These pension members are responsible for all investment decisions as well as for determining the right retirement payout amount in order to meet their lifestyle needs while also ensuring the money lasts their lifetime. This differs from DB pensioners who receive a payout amount based on a formula, regardless of the investment results. The risk for non-DB pensioners is entirely held by the individual.

Should DB pensioners worry?

A risk does exist for those who are currently contributing to their DB pension.  The plan sponsor will likely want to increase participant contributions to ensure the obligations of the pension promise can be met. Someone needs to pay for those longer-living pensioners. Current DB pension plan contributors are likely to pay more into the plan and therefore experience a decrease in their take-home salary. Some DB pensioners also receive health benefits. Many of these benefits have already been reduced and this trend is likely to continue.

Lee Anne Davies has worked as a consultant for insurance, wealth management, banking and financial education companies. She has a PhD in Aging, Health and Well-being and a Masters of Arts (MA) in Gerontology and Health Studies from the University of Waterloo and an MBA from Athabasca University’s Information Technology Management program. She’s also successfully completed the Canadian Securities Course and the Professional Financial Planning Course. To read more from Davies, visit her blog Agenomics.