In a world of pension freedoms, longevity risk falls on the individual. Clients must realise they will likely live longer than they think.
Mortality is not the nicest topic of conversation, but there is plenty of evidence that if clients do not have a realistic picture of how long they are likely to live, they are at risk of seriously poor outcomes.
There are many reasons why individuals may underestimate how long they can expect to live.
The most widely quoted figures are those for life expectancy at birth. Figures published in September by the Office for National Statistics put life expectancy at birth for a boy at just over 79 years and for a girl at just under 83 years.
Yet these figures can be deeply misleading. They reflect the many things that can cause premature death (such as accidents, suicide, diseases and so on) but if you survive all of this to reach retirement at 65 and still have in your mind the life-expectancy-at-birth figures, you would significantly underestimate the length of your retirement.
For example, the same ONS data source says that a man who reaches 65 can expect, on average, to live until he is nearly 84 and a woman until she is nearly 86.
To see the importance of this difference, consider a man who has heard he has a life expectancy of 79 and who retires at 65. He thinks his pension pot needs to last for 14 years on average. But it will need to last 19 years – more than a third longer.
One of the problems is that, in the absence of anything else to go by, people may think in terms of how long their parents or grandparents lived. But over a period of one or two generations, life expectancies have advanced dramatically.
For example, in the mid-1980s, ONS figures suggested a man of 65 could expect to live to 78 (rather than 84 as we assume today) and a woman of 65 could expect to live to 82 (rather than 86).
Even basing our assumptions on life expectancy around the age at death of our parents could leave us four to six years short on average, and we would be much further out if we used our grandparents as our reference point.
What is more, even these average figures conceal a great deal of variation and advisers need to think how far to take these into account when talking to clients.
What matters, of course, is not the average life expectancy of the average person, but the actual life expectancy of the person in front of you. And while this may be a delicate conversation to have, ignoring it can create serious problems.
Consider, for example, the differences between different parts of the country.
Latest figures for life expectancy at 65 in different parts of England and Wales show large variations.
For men, the range is from 80.9 years in Manchester to 86.6 in Kensington and Chelsea, while for women the range is from 83.8 in Manchester to 89.6 in Camden.
Although these figures do not include Scotland, it has similarly huge variations in life expectancy between different areas.
There is much more that could be said about why individuals may underestimate their own life expectancy and why headline figures might be much too low as a guideline for how long someone can expect to live for in retirement. There is also much more to be said about variations in life expectancy between different individuals.
But a key question for advisers is, given that clients may have a seriously inaccurate perception of how long they are likely to live, how far should you factor this into your conversations with them?
In the days when annuity purchase was the norm, this was much less of an issue. If a client was planning to buy an annuity and used full information about their health and other relevant factors, the annuity rate would reflect (as far as possible) their individual, specific life expectancy.
Crucially, the longevity risk would fall on the annuity provider. So even if the client underestimated how long they might live for, it would not greatly matter. Yet in a world of pension freedoms and drawdown, longevity risk falls on the individual.
If they do not save enough, partly because they underestimate how long their pot needs to last, and if they are tempted to draw down too quickly for the same reason, we have a problem.
Clients need to realise that, on average, they will live longer than they think and that there is some chance they will live a lot longer than they think. If they do not get that understanding from their advisers, where will they get it from?
Steve Webb is director of policy at Royal London