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Aging & Health Care – Kogod Now
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Kogod Now / Faculty Research  / Aging & Health Care
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Aging & Health Care

An International Finance Perspective

It’s no secret that the world’s population is aging.

Within the next decade, it is projected that people over 65 years of age will outnumber children under 5 for the first time in history, according to a United Nations study. Between 2005 and 2030, the number of centenarians across the globe is expected to quadruple.

Although increased longevity is a global phenomenon, it is projected to be most pronounced in developing countries, the result of reductions in infant mortality and infectious diseases.

International Finance Professor Robin Lumsdaine sat down with Kogod Now to highlight the business implications of these trends.

KN: Tell us about the effect that the world’s aging population has on financial stability.

Lumsdaine: The demographic outlook is one of the biggest challenges in international finance today. For example, in the aftermath of the recent financial crisis, many countries highlighted pension reform in their discussions of how to ensure financial stability going forward. It’s an emotionally charged and difficult issue, as the recent protests in Greece over such proposed reforms show. Even in this country, such changes are politically unpalatable.

From an economic perspective, the changing demographic landscape is especially worrying for countries like the United States, where the increase in health-care costs has far exceeded the overall rate of inflation, as shown in the graph below. This means that health-care costs are increasing much more rapidly in relative terms than many other prices, including wages. They are becoming a larger piece of the total pie for both individuals and governments, resulting in less being available for other needs.

KN: What does the aging population mean for the US government’s outlook?

Lumsdaine: As the proportion of elderly grows, so too do struggles in financing health care, social security, and pension programs. Many of these programs rely on a pay-as-you-go framework, meaning they are funded by contributions from the current working-age population.

The ratio of workers to beneficiaries, however, has fallen from 16 to 1 in the 1950s to just above 3 to 1, and it is projected to fall to 2 to 1 in 2031, according to the Social Security Administration (SSA).

As this ratio falls, obligations will continue to grow: the SSA estimated in its 2011 Report to Trustees that social security and Medicare, which currently make up over 8 percent of US GDP, will represent 11.7 percent of GDP in 2035—a nearly 40 percent increase.

KN: How did you become interested in studying the effect of changing demographics on financial stability?

Lumsdaine: As an economics graduate student, I began studying financial aspects that could influence decisions related to aging—such as the role of pensions in retirement decisions. First as a research assistant for two professors, and later in collaboration with them.

Eventually, this research led to a series of publications that considered the possible impact of policy changes—such as increasing the social security retirement age—on labor-force participation and retirement.

Subsequently, I was asked by the National Academy of Sciences to write a paper surveying the literature on factors affecting retirement decisions. The initial draft focused solely on financial factors; some of the non-economists in the room suggested non-pecuniary factors also played a role. As a result of that input, my research expanded to include the influence of nonfinancial factors on economic decisions, such as caregiving responsibilities and perceptions. This in turn led to my applying for—and receiving—two grants from the National Institute on Aging to conduct research in these areas.

KN: Wasn’t the move to Deutsche Bank rather unusual for someone working in aging and health care?

Lumsdaine: The move to Deutsche was related to my research in finance and econometrics—forecasting exchange rates and other financial prices and trading based on my forecasts—and it’s true that when I decided to move one concern I had was that my work on aging/healthcare would take a back seat. It turned out that as a strategist, I saw firsthand the significance of demographic shifts and how that might influence financial markets.

My role was very client-facing, and I was struck by the impending asset-liability mismatch that pension funds across the globe anticipated as a result of demographic projections. My expertise in aging and health-care issues provided added perspective when discussing financial challenges.

KN: And then you went to the Federal Reserve?

Lumsdaine: Yes. The firsthand experience I had of the recent financial crisis furthered my interest in the financial implications of the changing demographic landscape, carrying into my current research here at Kogod.

KN: Could you elaborate?

Lumsdaine: For example, there was a spike in retirement of grandparents to [instead of working] care for grandchildren and facilitate greater labor-force participation of the middle generation. My recent research paper, “The Incentive Effects of Grandchildren,” joint with Stephanie Vermeer, examines the interaction of grandparents’ retirement and caregiving decisions.

In our paper, we write: “The recent financial crisis has highlighted the importance of studying the role of grandparents providing care for grandchildren, for example, as a way for households to enable dual earning of the middle generation or to reduce third-party child-care costs.”

A lot of research exists on the impact on work of caregiving responsibilities for children or elderly parents or disabled spouses, but in those cases it is difficult to determine causality. Do caregivers become caregivers because they have flexible jobs? Or do they take flexible jobs because they need to be caregivers? Often the caregiving and work decisions occur simultaneously. In addition, concerns over access to health insurance can sometimes force potential caregivers to stay in the labor force and arrange for third-party care so that the true effect [in the absence of the health insurance constraint] is hard to measure.

But with retirement-age grandparents who are already working, that difficulty shrinks. Grandparents cannot directly control the timing of the arrival of grandchildren. We can therefore evaluate the effect on labor-force attachment in response to the birth of a grandchild. And because grandparents’ health insurance plans often do not extend to their grandchildren, that external effect is absent. Our research provides a fresh perspective on the tradeoff between work and caregiving.

As another example, I put out a piece earlier this year through the Center for Financial Stability, where I am a senior fellow in international finance. The piece addresses MetLife’s decision to exit the long-term care insurance market despite growing demand for such insurance, arguing that systemic risk considerations in the form of new capital requirements and financial regulation could discourage participation by some of the largest insurance providers, dealing a destabilizing blow to the viability of this important market. Although we’ve seen both health-care and financial regulation reform in recent years, the debates surrounding them have been largely separate and there has been little attention paid to the potential implications of one for the other.

KN: What spurred your recent interest in behavioral finance and the role of literacy in economic decisions?

Lumsdaine: In part it was the recent financial crisis; many investors didn’t understand the financial products they invested in and, hence, made bad decisions based on that lack of understanding. And these literacy concerns are not only relevant in the financial markets—an analogous situation exists with respect to health care, where lack of information or understanding can result in bad health-care decisions.

I have a recent paper that demonstrates how the way people understand and interpret information affects their assessments of their own health. Such assessments can, in turn, affect the decisions they make. That research, joint with Anneke Exterkate, considers the order (“sequencing”) and wording (“framing”) of survey questions regarding people’s perceptions of their own health. We found that individuals’ assessments of their health may be influenced by the questions that precede their assessment. We also found that we could better predict future major health events (such as the probability of a heart attack or stroke) by considering the respondents’ understanding of such assessment questions.

We used the Survey of Health and Retirement in Europe (SHARE), in which participants were twice asked a question about how they perceived their health on a scale of 1 to 5; the two questions had slightly different wording, and which question individuals received first was determined randomly. By taking into account which question was asked first when analyzing the responses, we found we could better predict future health outcomes of these individuals, even after controlling for a variety of factors such as smoking, obesity, age, and education. Our results emphasize that studies that use survey data may need to adjust for framing and sequencing effects when analyzing such data.

There are many ways in which population aging and health-care issues influence the financial markets. Lumsdaine shared a few examples:
  • • The use of structured derivatives to help banks and insurance companies hedge longevity risk (essentially, the risk that liabilities exceed projections due to people living longer)
  • • The severe underfunding of many private- and public-sector pension and health-care funds, and the impact of future pension and health-care obligations on firms’, as well as state and local governments’, balance sheets
  • • The projected change in asset allocation as the “baby boom” generation retires, and the implications for future equity and bond returns
  • • People deciding to postpone retirement to make up for losses to their retirement savings
  • • An increase in retirement of grandparents to instead care for grandchildren and facilitate greater labor-force participation of the middle generation
  • • A rise in the “discouraged worker” population—for example, those who were laid off and, rather than seek re-employment in a difficult labormarket environment, decide to retire
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