As people's lifestyles change, providers are having to rethink their understated life expectancy forecasts and accomodate for a longer-living population. Ian Owen reports
Recently, David Norgrove, chair of the Pensions Regulator, warned that UK companies may be seriously understating the size of their pension obligations because they are making unrealistic forecasts of the life expectancy of their former workers.
However, longevity is not the only issue. Potentially more concerning are the implications of the fact that we are living longer, but in ill health. Putting it bluntly, the time between contracting a debilitating illness, that requires care, and death is increasing - and that increase is significant.
Living longer
In 2001, the life expectancy at birth of females was 80.4 years and 75.7 for males. However, healthy life expectancy was just 67.0 years for males and 68.8 years for females, the difference being the time that a person can expect to live in poor health, and this is getting longer. In 1981, the expected time lived in poor health for men was 6.5 years; by 2001 this had risen to 8.7 years; for women, the rise was from 10.1 years to 11.6 years.
While the figures above are significant, the concern is that the real extent of the problem has not yet been revealed. Partnership Assurance has one of the most comprehensive databases of longevity of people with health conditions; the analysis shows a 15% increase in life expectancy for a typical client over the last four years. In 2002, an 87-year-old female requiring care would be expected to have survived for four years and eight months. In 2006, this increased to five years and four months. This represents a 4% annual increase compared with the general population, which is nearer 1% to 2% per year improvements. Assuming no population growth, we are looking at finding an extra £280m a year to fund care. Add in population growth and the figures become frightening.
Currently, around 40% of people aged over 85 receive residential care before they die and, at present, about 32% fund their own care at a cost of approximately £7bn. As baby-boomers reach retirement, the number of dependent older people will increase from approximately 3 million to over 6.4 million by 2051.
The real growth in spending on long term care (LTC) is colossal. According to the Joseph Rowntree Foundation, LTC expenditure needs to rise by around 315% in real terms between 2000 and 2015, the equivalent of 1.8% of GDP. For most people this will mean self-funding, as the Government, which faces ever-larger care bills, is unlikely to pick up the tab.
Options
So what are the options available?
The pre-funded option has not proved popular with the market and at the moment only Partnership Assurance offers a plan. The firm remains committed to the pre-funded market but understands why it has proved unpopular as it is subject to the same, if not more, apathy as pensions. The market started in the 1990s and was largely driven by anxieties about new rules introduced under the Health and Community Care Act, which came into force in 1993. Without a further call to action and until the public really becomes aware of the LTC issues, this market is expected to remain fairly niche.
There are a range of options within the immediate-needs spectrum and the market is complex, as clients are able to structure their care costs in several ways: by self-funding some of the costs; by financing them through an investment-backed structure, or through an immediate-needs annuity and more recently through equity release. It is further complicated by the addition of inflation-proofing payments and the ability to capital-protect part of the costs.
Investment-backed care is at present the most popular option, however, the concerns are that many advisers fail to truly understand the effects of longevity and the implications on funding.
The Care Risk Assessment Model (CRAM), a statistical model developed alongside Watson Wyatt, shows that, on average, 30% to 40% of customers would be worse off under an exclusively investment bond-backed care plan than an annuity-backed plan.
The simple reason for this is that estimated mortality is calculated on an average basis, with some dying early and some dying much later. Those who die later than the anticipated mortality will face a funding shortfall as a bond, assuming normal growth projections, has a very finite life.
For example, a 91-year-old lady who required care took out an investment bond. She faced a 38.1% chance that she will run out of funding with a mean shortfall of £26,051. In 25% of these simulations she faced a shortfall of £50,390 or more, and in 10% of these £79,718 or more.
All advisers are recommended to use CRAM as it is anticipated the Financial Services Authority will make such an assessment compulsory at some point in the future.
Solution
A simple solution for someone concerned about dying early and therefore not maximising the benefit from an annuity, but also with finite resources and equally concerned (or actually pleased) about living longer, is to combine a bond for immediate needs and deferred annuity for the long-term mortality risk.
There have been a number of product innovations in the immediate-needs annuity market over recent years, as illustrated by the examples below:
• Index linking - Most plans allow an escalation in policy benefits to help combat the effects of LTC inflation.
• Deferment periods - For clients who have finances to cover the immediate cost of care and can afford to defer paying for an annuity, the savings can be dramatic. For example, a man aged 88 with a moderate impairment could save almost £30,000 by deferring by three years assuming a requirement to fund £1,000 a month. Without a deferment period he would have to pay £37,752, while, if he took out a three-year deferment period he would only pay £8,812.
• Partial capital protection - By using an immediate-needs annuity and decreasing term assurance, clients can protect a percentage of their premium typically up to 75% of the annuity value. Take for example, a male aged 88, with mild impairment, £1,000 monthly benefit required, who has paid a £58,453 premium, inclusive of a 50% capital protected totalling £29,227. If death occurs within 12 months, total benefits paid would be £12,000 and £17,227 would be returned to the estate.
If death occurs after 30 months, total benefits paid would be £30,000 and nothing would be returned to the estate.
• Total capital protection - By using an immediate care annuity and a whole of life contract, a client can guarantee up to the total sum assured is returned regardless. This is obviously much more expensive but may suit clients who believe they are going to be short lived.
Equity release is another way of funding care that has become more popular in recent years. Currently, some 40,000 properties a year are compulsorily sold to fund long term care. With the Government unlikely to shoulder the burden of it, this trend is likely to continue.
Equity release
Therefore, for some, equity release may be a better option, enabling them to remain in their home. Equity release for care is likely to be the biggest growth area over the next few years.
Until recently, using equity release to fund care could have been possible grounds for misselling. This is because those requiring care due to poor health are subject to decreased longevity, however, traditional equity release providers use standard mortality tables; greatly to the detriment of those in poor health. There is now a fully medically underwritten equity release product available enabling advisers to offer solutions to impaired lives.
Therefore, medically underwritten equity release can be used to effectively fund the care of those who are sick today.
Those retiring now who are looking to equity release to fund the good retirement years and let the taxpayer fund the years to come in care should bear in mind that, given the pressures on Government spending, the standard of care they are likely to receive may well fall short of their expectations.
Care is an issue which should ideally be discussed well before it is required, when there are fewer emotive issues at hand. Advisers need to develop holistic retirement plans for their clients at retirement, which take account of the fluctuating need for expenditure. This should ensure adequate resources remain to fund the standard of care their clients may want in later life.
Ian Owen is the chairman of Partnership Assurance
