Facing the Pension Shift: 3 Ways Actuaries Must Adapt

Estimated Reading Time: 5 minutes

Initial Context

We all know the glaring statistics. The world is aging rapidly in most regions, creating a lot of uncertainty about how retirements will pan out. Interest rate fluctuations and unpredictable inflation present challenges to accumulating enough money to maintain reasonable lifestyles post-retirement. While people continue to live longer after retiring, necessitating the need for retirement funds, the real question is whether actuaries will continue to play a role in retirement benefits planning in the future. This question is complex, with multiple perspectives, making it better to examine various macro-trends rather than attempting a definite yes or no prediction, which is likely to be wrong.

The real concern is that our views are often based on historical and existing experience. However, experience alone cannot reliably predict the future. Sudden changes might leave little room and time for us to up-skill and adapt to remain relevant. Therefore, our projections should consider both experience and macro-trends to understand the holistic picture of the future of retirement benefits.

Understanding Retirement Benefit Types

It is essential to have a basic understanding of the main Retirement Benefit (RB) types. Defined Benefit (DB) plans promise a pension and/or gratuity upon retirement based on a stated formula. Actuaries calculate the financial impact of these guarantees, and reserves are set up so that employers can fulfill their promises to employees as they retire. DB plans were suitable for the previous generation when salaries and raises/increments were low, interest rates were high, and job stability was common. The employer bore the risk of funding retirement benefits for employees. However, with low long-term interest rates, frequent job changes, and increased life expectancies, the financial impact of DB plans has grown significantly. This is why employers and national schemes are shifting to Defined Contribution (DC) plans, where contributions are deducted from employees' salaries and matched by employers. The return on investment depends on the market and fund profile, with no final guarantee, thus shifting the risk from the employer to the employee. Pension payments have increased as people are living longer than ever before, as shown by the continuous rise in life expectancies worldwide.

Current Trends and Future Opportunities

From 2012, there were active discussions that all plans would eventually convert from DB to DC, leading to a decline in actuarial relevance and consulting business. However, until 2024, there has been a 5-10 times increase in consulting business for RB in regions like Middle East & North Africa (MENA) and South Asia due to several factors:

• DB IAS19 valuations by actuaries increased as many countries, like those in the Gulf Cooperation Council (GCC), adopted International Financial Reporting Standards (IFRS) after 2018.

• Employers who previously did not offer retirement benefits started doing so as a perk, along with health insurance and group life insurance.

• Peer review of DB valuations by another actuary increased work.

• The shift from DB to DC requires specialized projects from actuaries to ensure no loss in benefits between generations.

• The shift to DC has not been as aggressive as predicted in 2012.

We must now consider whether this growth is a temporary dead-cat bounce or a sustainable trend for the future.

Additional Context and Implications

Over the past few decades, there has been a marked decline in the prevalence of DB plans. These plans, which promise specific payouts upon retirement based on salary and years of service, have become increasingly costly for employers to maintain. Factors contributing to this decline include:

Longevity Risk: As people live longer, the cost of providing lifetime retirement benefits has increased significantly.

Market Volatility: Economic downturns and market volatility have made it challenging for pension funds to achieve the necessary returns to meet their obligations.

Regulatory Burdens: Increased regulatory requirements and funding rules have added complexity and cost to managing DB plans.

DC contribution plans have become the dominant form of retirement savings in many countries. Unlike DB plans, DC plans do not promise a specific retirement benefit. Instead, the retirement benefit depends on the amount contributed and the investment performance of those contributions. This shift has several implications for actuaries:

• The actuarial skills needed to manage the longevity and investment risks of DB plans are less relevant for DC plans, which focus more on asset management and investment advice.

• Actuaries are finding new roles in areas such as retirement planning, financial wellness programs, and advisory services, helping individuals make informed decisions about their retirement savings.

• There is growing demand for expertise in decumulation strategies, ensuring that retirees can effectively manage their savings to provide income throughout retirement.

There are also many recommendations for tweaking elements of the schemes to make them more sustainable, especially for national social retirement schemes. Defined Ambition (DA) is a hybrid of DB and DC poised to increase in the future, offering a compromise with a minimum guaranteed benefit and additional benefits based on investment performance.

Meta-Trends and How Actuaries Can Assist

Demographic shifts, such as the aging population and changing workforce dynamics, are influencing the pensions field. As the global population ages, there is an increasing need for sustainable retirement solutions. Actuaries are well-positioned to address these challenges by developing innovative pension products and strategies that cater to the diverse needs of the aging population. This includes creating hybrid plans that combine features of both DB and DC plans and designing lifetime income solutions that provide financial security throughout retirement.

The role of actuaries in the pensions field varies globally, depending on the specific pension systems in place. In some countries, traditional DB plans are still prevalent, while in others, DC plans dominate. Actuaries working in different regions must understand the unique regulatory and economic environments that affect pension systems. This global perspective opens opportunities for actuaries to work internationally, offering their expertise in developing and managing pension plans tailored to local conditions.

Technology and innovation are reshaping the pensions field, providing new tools and methodologies for actuaries. The use of advanced analytics, artificial intelligence, and machine learning allows actuaries to better predict outcomes and optimize retirement strategies. Blockchain technology is being explored for its potential to enhance transparency and security in pension management. By staying at the forefront of technological advancements, actuaries can offer more efficient and effective solutions to their clients and employers.

One of the critical challenges in the pensions field is ensuring retirement income adequacy. Many individuals are at risk of outliving their retirement savings due to inadequate contributions, poor investment decisions, and increasing life expectancies. Actuaries play a crucial role in addressing this issue by designing retirement plans that encourage sufficient savings, offering investment advice to maximize returns, and developing annuity products that provide guaranteed income for life. By focusing on these areas, actuaries can help secure financial stability for retirees.

Actuaries can also make a significant impact through collaborative efforts and advocacy. By working with policymakers, employers, and industry organizations, actuaries can influence the development of pension policies and regulations that promote retirement security. Participation in professional bodies and contribution to public debates on pension reform can help shape a more robust and equitable pension system. Advocacy for financial literacy and education is another area where actuaries can contribute, empowering individuals to make informed decisions about their retirement.

Evolving and Transforming in the Actuarial RB Workspace

While the traditional role of actuaries in managing DB plans may be declining, the pensions field is not necessarily dying for actuaries. Instead, it is evolving. Actuaries are adapting to new roles and expanding their skill sets to stay relevant in the changing landscape:

• Retirement Consulting: Actuaries are increasingly involved in retirement consulting, helping employers design and manage DC plans, and advising on investment strategies and plan governance.

• Risk Management: The principles of risk management that actuaries apply to DB plans are also applicable to DC plans, particularly in managing investment risks and helping plan sponsors develop risk mitigation strategies.

• Regulatory Compliance: Actuaries play a crucial role in ensuring that pension plans comply with regulatory requirements, whether DB or DC. This includes advising on funding strategies, plan design, and reporting.

• Data Analytics: With the rise of big data, actuaries are leveraging data analytics to provide insights into participant behavior, plan performance, and demographic trends, helping to optimize retirement outcomes.

• Innovative Schemes: From corporations to national social schemes, actuaries can play a pivoting and data-driven role in suggesting reforms to make those plans more sustainable. The actuarial role remains relevant for innovative schemes like DA.

The future of pensions for actuaries is not a story of decline but one of transformation. As the retirement landscape continues to change, actuaries will need to:

Adapt and Diversify: Broaden their expertise to include areas such as investment strategy, behavioral finance, and data analytics.

Embrace Technology: Leveraging technology and advanced analytics can provide deeper insights and more effective solutions for retirement planning.

Focus on Lifelong Learning: Continuous professional development is essential to stay abreast of industry trends and emerging practices.

Innovate: Look for innovative solutions to address the challenges of retirement security, such as developing new financial products and services that better meet the needs of retirees.

Conclusion

While traditional defined benefit pension plans are declining, the pensions field is far from dying for actuaries. Instead, it is undergoing significant transformation. Actuaries who adapt to the evolving landscape, embrace new opportunities, and expand their skill sets will continue to play a vital role in ensuring retirement security for future generations. The field of pensions remains a dynamic and essential area for actuarial practice, with new challenges and opportunities on the horizon. By up-skilling and adapting, actuaries can seize new opportunities from these risks as well.