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
ebooksA celebration of British elections
  • Get to the point
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

Guru Careers: Software Engineer / Software Developer

£40-50K: Guru Careers: We are seeking an experienced Software Engineer / Softw...

Ashdown Group: Trainee Consultant - Surrey/ South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Ashdown Group: Trainee Consultant - Surrey / South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Recruitment Genius: Claims Administrator

£16000 - £18500 per annum: Recruitment Genius: This is an excellent opportunit...

Day In a Page

Fishing for votes with Nigel Farage: The Ukip leader shows how he can work an audience as he casts his line to the disaffected of Grimsby

Fishing is on Nigel Farage's mind

Ukip leader casts a line to the disaffected
Who is bombing whom in the Middle East? It's amazing they don't all hit each other

Who is bombing whom in the Middle East?

Robert Fisk untangles the countries and factions
China's influence on fashion: At the top of the game both creatively and commercially

China's influence on fashion

At the top of the game both creatively and commercially
Lord O’Donnell: Former cabinet secretary on the election and life away from the levers of power

The man known as GOD has a reputation for getting the job done

Lord O'Donnell's three principles of rule
Rainbow shades: It's all bright on the night

Rainbow shades

It's all bright on the night
'It was first time I had ever tasted chocolate. I kept a piece, and when Amsterdam was liberated, I gave it to the first Allied soldier I saw'

Bread from heaven

Dutch survivors thank RAF for World War II drop that saved millions
Britain will be 'run for the wealthy and powerful' if Tories retain power - Labour

How 'the Axe' helped Labour

UK will be 'run for the wealthy and powerful' if Tories retain power
Rare and exclusive video shows the horrific price paid by activists for challenging the rule of jihadist extremists in Syria

The price to be paid for challenging the rule of extremists

A revolution now 'consuming its own children'
Welcome to the world of Megagames

Welcome to the world of Megagames

300 players take part in Watch the Skies! board game in London
'Nymphomaniac' actress reveals what it was really like to star in one of the most explicit films ever

Charlotte Gainsbourg on 'Nymphomaniac'

Starring in one of the most explicit films ever
Robert Fisk in Abu Dhabi: The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers

Robert Fisk in Abu Dhabi

The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers
Vince Cable interview: Charging fees for employment tribunals was 'a very bad move'

Vince Cable exclusive interview

Charging fees for employment tribunals was 'a very bad move'
Iwan Rheon interview: Game of Thrones star returns to his Welsh roots to record debut album

Iwan Rheon is returning to his Welsh roots

Rheon is best known for his role as the Bastard of Bolton. It's gruelling playing a sadistic torturer, he tells Craig McLean, but it hasn't stopped him recording an album of Welsh psychedelia
Morne Hardenberg interview: Cameraman for BBC's upcoming show Shark on filming the ocean's most dangerous predator

It's time for my close-up

Meet the man who films great whites for a living
Increasing numbers of homeless people in America keep their mobile phones on the streets

Homeless people keep mobile phones

A homeless person with a smartphone is a common sight in the US. And that's creating a network where the 'hobo' community can share information - and fight stigma - like never before