Last month, the Centers for Disease Control and Prevention (CDC) released their most recent life expectancy in the United Statesvsy estimates, and sadly, the report revealed that once again the average number of years remaining to Americans has decreased. As reported recently, life expectancy at birth is now 76.4 years (in 2021), compared to 77 a year earlier. This is a decline of about 7 months over a one-year period, bringing life expectancy back almost a quarter of a century to 1996.
This decline is certainly terrible news. Yet, as financial educators and researchers, we are concerned that the way this information is presented to the public is widely misinterpreted. Worse still, we fear that many Americans are reading such reports and taking the wrong actions, based on a misunderstanding of how mortality information should be incorporated into retirement planning and savings. Instead of panicking, we should adopt a risk management mindset.
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Twin Crisis in Retirement Decision-Making
Our research highlights two emerging crises for Americans making financial decisions about their future life: their financial illiteracyand the difficulty they have planning for retirement.
For example, less than half of adults can correctly answer three basic financial questions about interest rates, inflation and risk diversification, and only about 40% of Americans say they have ever even tried to find out how much to save for retirement. In addition, two-thirds of those surveyed say they have less than a month’s income saved for emergencies, and a third have no retirement savings account.
So imagine what the financially illiterate and undersaving public will think when they see these new life expectancy estimates. Many may say: “Well, if I’m only going to live to be 76, then why should I bother saving anything for retirement?” Or, even worse, they could extrapolate this 7 month drop and conclude that in about 130 years, human life expectancy will be zero!
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What can be done?
Those who understand statistics and mathematics might scoff at such erroneous conclusions for several reasons. For one thing, linear extrapolations produce absurd results, as shown above. On the other hand, the CDC’s life expectancy report refers to a period Rather than a cohort measure. The periodic life table represents deaths in a population during a specific time period, while the cohort table includes predictions of anticipated changes in future survival rates for people alive today.
So you might be wondering how can we help average Americans understand what the new data means? We propose that it is high time that the CDC, and by extension the financial media, began to report not only on the average lifespan of Americans (the 76.4 years shown above), but also on the standard deviation or dispersion in years of mortality around this average. This is because people tend to misinterpret life expectancy figures. how long they will livebut there is actually a fairly wide range or dispersion around the mean.
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In the case of older Americans, this range is easily on the order of 10 years (one standard deviation around the mean), which means that newborns can expect to live between 60 and 90 years. People who want to be more confident about their lifespan, in order to better prepare for retirement, will need to add another standard deviation or decade of life, which will bring them to 100 years. This approach provides a better estimate of longevity risk, or the chance that people outlive their money in old age. The following figure provides an idealized view of longevity risk, where life expectancy is only a midpoint.
Source: Authors’ elaboration.
Interestingly, the the evidence suggests that retirees grossly underestimate their longevity risk, providing policymakers with a rationale to support defined-benefit pensions and social security. It also explains why the US Congress recently passed legislation emphasizing the importance of income annuities to better protect people against longevity risk. In fact, the dispersion displayed in the figure explains precisely why life annuities are so important in a well-designed retirement plan.
Annuities help insure those who live longer than average in “pooling” longevity risk with those who live less long. Alas, focusing only on the average eliminates one of the biggest challenges of retirement: the uncertainty of it all.
The key to risk management to avoid catastrophe
Our plea is therefore twofold.
First, the CDC and other news outlets should start publishing not just average life expectancy numbers, but also the range or spread around that concept, to better guide the millions of Americans who suffer from low financial literacy and poor preparation for retirement.
Second, Americans themselves should stop thinking, budgeting, and planning for their retirement as if it were a fixed, known duration, and instead adopt a risk management mindset.
Olivia S. Mitchell is a professor at the International Foundation of Employee Benefit Plans and a professor of insurance/risk management and business economics/public policy at the Wharton School at the University of Pennsylvania. Moshe A. Milevsky is a professor of finance and a graduate faculty member of mathematics and statistics at York University in Toronto.