Investment: Actuaries calculate the costs of low inflation

MOST PEOPLE know the old joke about an actuary being someone who finds the life of an accountant too exciting. Yet just because they don't tend to make waves does not mean that actuaries cannot have something useful to tell us.

In fact, it is probably at excitable times such as these that actuaries, with their long, professional perspective and fondness for dry statistics are most needed to put investors' wilder aspirations into a more reasoned framework.

It may be 15 years since inflation around the world started its long decline, but that has not stopped the actuarial profession from now deciding it is about time to get round to looking in more detail at the investment implications of a low-inflation world. A working party of actuaries presented their findings a few days ago to the Institute of Actuaries, their professional body.

The primary purpose of the working party was to examine the implications of low inflation for the life insurance industry and its customers. As is demonstrated by the case of Equitable Life and guaranteed annuity rates, to which I referred two weeks ago, there could be no more topical subject - nor one which, as my postbag demonstrates, so badly cries out for the dry, long-term perspective of the kind that actuaries are there to provide.

Anyone who was at the Equitable Life annual general meeting two weeks ago, when the board of the venerable mutual society was lambasted by irate policyholders, will have seen for themselves the strength of feeling about annuity rates and investment returns.

There is no doubt that the Equitable has failed to handle its PR as well as it might, but its arguments - when you dig behind the actuarial prose in which much of its communications with policyholders are couched - are far more robust than you would gather from reading press reports of the meeting.

The actuaries, in their working paper, touch on some of the issues which are raised by the guaranteed annuity issue. They give a number of good reasons why low inflation is probably here for at least the next 10 years. These include demographics and improved communications.

The key consequence of these trends, the actuaries reckon, is the probability of further declines in real interest rates and a consequent decline in medium and long-term investment returns. This last assumption is, of course, the point that most investors find hardest to stomach. Surely, given that the stock and bond markets have been so strong in the past few years, the bonuses and assumed returns on pensions and other long-run insurance policies should be getting better, not worse?

Yet declining sharply is what bonus rates have been doing. This trend comes with the full blessing of the actuarial profession. Their caution about future investment returns is also why the Financial Services Authority is now requiring the financial services industry to cut the rates of return used to illustrate the projected value of new life policies and other contracts by 1 per cent from current bands. If anything, the actuaries think the cuts do not go far enough. They believe the illustration rates should be reduced to around 5 per cent (before inflation).

In the short run, of course, this meanness looks ridiculous. In the five years since actuaries started warning publicly about the inevitability of lower future investment returns the financial markets have simply refused to take notice. Wall Street and the London stock market have just completed their most buoyant four-year run of consecutive positive returns this century.

But the actuaries are right to warn that on their much longer time perspective the stronger the markets are, the more vulnerable to a future correction they become. Unfortunately, of course, the actuaries are unable to give us any idea about exactly when or how that correction is likely to happen.

While it is perfectly legitimate (if unwise) for investors to load up on shares, hoping to catch the tail end of the bull market, responsible insurance companies have no such leeway. They must cut their cloth now to match their long-term liabilities.

The interesting point the actuaries make is that this process, however justified and necessary, is going to cause distress for many insurers, and not just those wrestling with the consequence of guarantees that were so lightly given in the very different market conditions of the 1970s and early 1980s.

The reason is that any continuation of the world of falling investment returns and low inflation inevitably increases the risk of statutory insolvency for any insurance company that has pared its reserves of "free" assets over the years.

The irony, however, the actuaries conclude, is that people reaching retirement age now stand to do exceptionally well out of their pension policies, at least in real terms (adjusting for inflation). The real rates of return (before expenses) on a 20-year policy maturing in 1988, 1993 and 1998 were 9 per cent, 12 per cent and 12 per cent respectively.

Even allowing for lower annuity rates, the value of the pensions these are now providing is much higher than most people have enjoyed in the past - and certainly much higher than most can expect to receive in the future.

A 45-year-old man will need to save roughly two and a half times as much as someone who is now 65 in order to earn the same amount of pension in real terms, the actuaries estimate. That is what permanently low inflation threatens us with. In other words, though they of course do not spell it out in such explicit terms, the wrong people are making all the fuss about guaranteed annuities. Those with the real pension problems have yet to be heard from.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Arts and Entertainment
Lionel Richie has made the top spot after a strong Glastonbury performance
musicAnd what's more it's the last Sunday night chart topper - ever!
News
news
Life and Style
The collection displayed Versace’s softer side, with models wearing flowers and chiffon dresses in unusual colourings
fashionVersace haute couture review
Arts and Entertainment
DJ Chris Moyles who claimed to be a second-hand car dealer in a bid to save up to £1 million in tax, a tribunal has found
radio
Arts and Entertainment
'The Leaf'
artYes, it's a leaf, but a potentially very expensive one
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Assistant / Buyer

£15000 - £17000 per annum: Recruitment Genius: This company offers a range of ...

Recruitment Genius: Customer Service Advisor

£15000 - £16000 per annum: Recruitment Genius: Customer Service Advisors are r...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45K: SThree: SThree were established in 1986....

Recruitment Genius: Compliance Manager

£40000 - £60000 per annum: Recruitment Genius: A Compliance Manager is require...

Day In a Page

Greece says 'No': A night of huge celebrations in Athens as voters decisively back Tsipras and his anti-austerity stance in historic referendum

Greece referendum

Greeks say 'No' to austerity and plunge Europe into crisis
Ten years after the 7/7 terror attacks, is Britain an altered state?

7/7 bombings anniversary

Ten years after the terror attacks, is Britain an altered state?
Beautiful evening dresses are some of the loveliest Donatella has created

Versace haute couture review

Beautiful evening dresses are some of the loveliest Donatella has ever created
No hope and no jobs, so Gaza's young risk their lives, climb the fence and run for it

No hope and no jobs in Gaza

So the young risk their lives and run for it
Fashion apps: Retailers roll together shopping and social networking for mobile customers

Fashion apps

Retailers roll together shopping and social networking for mobile customers
The Greek referendum exposes a gaping hole at the heart of the European Union – its distinct lack of any genuine popular legitimacy

Gaping hole at the heart of the European Union

Treatment of Greece has shown up a lack of genuine legitimacy
Number of young homeless in Britain 'more than three times the official figures'

'Everything changed when I went to the hostel'

Number of young homeless people in Britain is 'more than three times the official figures'
Compton Cricket Club

Compton Cricket Club

Portraits of LA cricketers from notorious suburb to be displayed in London
London now the global money-laundering centre for the drug trade, says crime expert

Wlecome to London, drug money-laundering centre for the world

'Mexico is its heart and London is its head'
The Buddhist temple minutes from Centre Court that helps a winner keep on winning

The Buddhist temple minutes from Centre Court

It helps a winner keep on winning
Is this the future of flying: battery-powered planes made of plastic, and without flight decks?

Is this the future of flying?

Battery-powered planes made of plastic, and without flight decks
Isis are barbarians – but the Caliphate is a dream at the heart of all Muslim traditions

Isis are barbarians

but the Caliphate is an ancient Muslim ideal
The Brink's-Mat curse strikes again: three tons of stolen gold that brought only grief

Curse of Brink's Mat strikes again

Death of John 'Goldfinger' Palmer the latest killing related to 1983 heist
Greece debt crisis: 'The ministers talk to us about miracles' – why Greeks are cynical ahead of the bailout referendum

'The ministers talk to us about miracles'

Why Greeks are cynical ahead of the bailout referendum
Call of the wild: How science is learning to decode the way animals communicate

Call of the wild

How science is learning to decode the way animals communicate