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Challenges posed by the ageing EU population for the financial sector - Economic and monetary challenges

La forza del destino

By Hufeld Felix - President, Federal Financial Supervisory Authority, Germany (BaFin)

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The world around us is constantly changing, often at a rapid rate. Take, for example, the triumph of smartphones, which 30 years ago would have seemed like a prop from Star Trek. Nowadays, consumers use them to conduct their financial transactions. The world our children will live in when they are grown up will be very different again from the one of today. In particular, the mega-trend of demographic development will make its mark, including in the financial sector. Population changes generally occur more slowly than those in the realm of technology, but they are usually longer-lasting as well.

One aspect of demographic change is increased life expectancy. In the dry language of the insurance world, this is known as the longevity risk. It is truly difficult to foresee the effects of increased life expectancy on the European financial sector, since the different variables at play are too multifaceted. They depend decisively on both the current and future economic, social and labour-market decisions – and are largely outside the sphere of influence of the financial sector.

In view of the current situation of social funds and population development, however, it does not take a prophet to predict that the whole of Europe will see a growing importance of private old-age provision as opposed to the contributions-based system. Clearly, this will change both markets and products.

So we are left facing a prime example of the “horizon problem”: it is currently hard to anticipate the specific effects that demographic change will have on the availability and trade of financial instruments, and to what extent long-term guarantees or insurance commitments will be able to be fulfilled. In addition, due to risks which cannot be assessed, all regulatory reporting requirements are outside the scope of the price changes which can currently be estimated. Yet in the field of demography, we are moving from the “unknown unknowns” towards the “known unknowns” – we already know that there are longevity risks.

The effects of increased life expectancy on the financial sector are not an inevitable fate, however. They can be mitigated, at least, by constant adaptation to changing parameters: for example, when financial market participants can make a realistic assessment of how the State, undertakings and individuals will respond to these changes.

The effects of increased life expectancy on the financial sector are not an inevitable fate, however. They can be mitigated, at least, by constant adaptation to changing parameters.

Yet even when undertakings provide the right offers, there has to be sufficient interest on the demand side. Although the promotion of financial literacy is a challenge for the whole of society, the supply side should have an interest in getting involved as well. In this way, the industry does not only create broad public awareness but reduces its operational, reputational and legal risks – and is able to boost sales.

In life insurance, for example, demographic change is affecting the determination of biometric calculation assumptions and the product design. For instance, pension products which combined coverage in the event of death with a one-off endowment dominated the German market for a long time, but in recent decades’ annuity insurance has been gaining in popularity.

Actuaries are ensuring that the tendency to live longer is appropriately taken into account by further developing mortality tables. Supervisors, for their part, have to require undertakings to base their new business on up-to-date mortality tables and increase the premium reserves for existing business.

But supervisors and regulators can only provide support to a certain extent to enable individuals to make decisions with far-reaching consequences. We must ensure that Europe has a financial system characterised by stability and integrity, in which bank customers, insured persons and investors can have confidence. Moreover, European regulators should make sure that risk carriers possess the necessary knowledge, skills and expertise, and that they comply with qualitative and quantitative standards when it comes to transferring longevity risks to insurance undertakings, financial institutions and the capital markets.

If demographic change means more personal responsibility, comprehensive information for consumers and the highest possible level of transparency on the financial markets are called for. Apart from regulators, communication technology – such as smartphones – can also play a certain role in this process.