Life expectancy, or mortality, is an integral part of determining how much a sponsor of a defined benefit plan must contribute to the trust fund to pay for the promised benefits.
In actuarial science, the mortality assumption is not just the answer to the question “how long will I live?”. It is instead more of an analysis of the chance of survival of one more year at the current age. Typically, a mortality table will give the probability that a group of people, usually measured in per-thousands, will die during the next year. The group could be a general group, or be specific to a certain gender, race or occupation. For example, for every 1,000 people living at age 75, a mortality table tell you how many are expected to die during the upcoming year, not how long will those 75-year-olds be expected to live. (Disclaimer – yes, the application of the mortality table is more complicated than what I’m describing – this is just the general idea.)
The actuary uses the mortality table to help the LOSAP sponsor determine the value of the accrued benefits and therefore save to pay those benefits. That is an important distinction – that the actuary is helping the sponsor accumulate an appropriate amount of money to pay promised benefits. Although that annual contribution feels like the “cost” of the LOSAP, the true cost of the LOSAP will not be known until the last participant is paid the last dollar. One of the goals would be at the end of the life of the LOSAP, that the exact amount of money in the Trust is there to pay out the final benefit, leaving the Trust at zero.
But it is interesting to think about how long a person is expected to live, especially from a cash-flow standpoint. The Centers for Disease Control and Prevention issues a report annually called Health, United States. The 2017 version contains charts with life expectancy at birth, age 65 and age 75. You can find that table by following this link: https://www.cdc.gov/nchs/hus/contents2017.htm#015
Based on 2016 data, at birth a male is expected to live to age 76.1. A 65-year-old is expected to live another 18 years, or to age 83. A 75-year-old is expected to live another 11.3 years, or until age 86.3.
So what this says is, when a male is born, he is expected to live 76 years. But, if that male survives to age 65, then at that point he is expected to live to 83, or 6 more years than was expected at birth. If that same male lives another 10 years to age 75, he is expected to gain about 3 more years of life expectancy compared to age 65, or live to 86.
One interesting thing about this table relative to LOSAP (or any pension) is that when the NY State LOSAP statute was adopted in 1990, a 65-year-old male was expected to live another 15.1 years. So in the 30 years since LOSAP was adopted, the average 65-year-old male now will live to collect his benefit roughly 3 more years. Another interesting point is that from 2012 to 2016, the life expectancy of an average 65-year-old male has not improved much – it has stayed right around 18 years.
The general increase in life expectancy since 1990 has caused LOSAP sponsors to have to make additional contributions to fund for the additional benefits that are expected to be paid. Those increased contributions happen slowly over time if the mortality table isn’t changed, or more rapidly and targeted when the actuary changes the mortality assumption.
While this post is not meant to be an exhaustive look at how mortality assumptions impact the calculation of contributions, we hope it is helpful in providing some general context.