Consensus on the potential impact of population aging on asset values varies from the benign to the extreme.
Population aging, implications for asset values, and impact for pension plans: an international study considers the impact of both population aging on asset values as well as pension plan risk in an economic capital framework over the period of current members’ liabilities – areas in which pension professionals and actuaries could benefit from broadening perspective and analysis.
Despite there being little consensus, the effect of population aging on investment returns remains a hot button topic within academic literature. To date, study conclusions range from catastrophic impact, described as “asset meltdown”; to a moderate effect on the markets but no meltdown; to a total rejection of the asset-meltdown hypothesis. This paper aims to identify the sensitivity of asset returns to demographic factors, while simultaneously illustrating the impact of varying the demographic factors on the funding of pension plans in Canada, the UK, and the US.
This paper also identifies others where earlier results are presented and shows that demographics have a direct influence on the asset returns and inflation rates generated. The impact of including demographics is illustrated for generalized pension plans in Canada, the UK, and the US for the lifetime of the current members.
Variations in the future paths of the demographics have a material effect on the funding of Canadian pension plans, but not so for either of the UK or the US pension plans. A portfolio of country-specific equities and bonds was modelled for each of the country-specific pension plans. It was also found that the risk exposure in Canadian pension plans due to these varying future demographic paths could be mitigated by employing a portfolio that includes non-Canadian assets.
Pension professionals and actuaries do not typically consider the impact that population aging has on asset values nor do they typically consider risk for pension plans in an economic capital framework over the period of current members’ liabilities. This research project has shown both of these considerations to be relevant to pension plan funding and risk management. The profession could benefit from a broadening of perspective and analysis in the identified areas.
Canadian pension plans most affected
An interesting finding is that the biggest impact is on Canadian pension plans as it affects rates of return associated with equities and bonds. Canada is most impacted in contrast with the US and the UK because of the impact of the baby boom generation. The reason for this is likely that Canada has experienced a larger reduction in fertility rates since WWII than either the UK or the US. Also, Canadian population mortality has improved more than in the US.
“The bottom line is that the finances of Canadian pension plans are more exposed to the demographic effect on investment returns than plans in the UK or the US.” Says one of the paper’s authors, Stephen Bonnar, FCIA, “In addition, they may be exposed to, the double whammy of any plan-specific longevity risk exposure.”
The findings in this paper, and its predecessors, should be of interest to pension practitioners and investment asset managers. Read the full paper for all the details.