Just 22% of surveyed pension plans considered hedging longevity risk: PwC

by Artemis on September 25, 2012

This telling statistic comes from some research undertaken by PwC which looked at defined benefit pension plan valuations in the UK and what they were doing, or planning to do, to overcome rising deficits. PwC surveyed 98 UK defined benefit pension schemes and found that on average they will likely need an extra three years to plug rising deficits, taking the average repayment period to eleven years.

Jeremy May, pensions partner at PwC, said:

“The difficult market combination of low gilt yields and eurozone uncertainty is hitting pension schemes hard. Many companies now face the stark choice of ploughing considerably more cash into their pension scheme, or being saddled with the debt for longer. In many cases, lack of cash availability means the decision is simple.

“Even if sponsors have access to cash, they are often choosing to reserve it to reinvest in their business and promote growth and covenant enhancements, rather than have it tied up in the pension scheme.

“The average recovery plan length provides a useful indicator of the state of the industry, but provides only part of the story and masks a wide range of recovery plans. In some cases, companies will need recovery plans considerably longer than 11 years to meet their increasing pension deficit.

“It is vital that employers take a proactive approach to managing their pension risks as they are becoming an increasing burden on UK employers, at a time when they are looking to conserve their cash.

“With average recovery plans almost certain to rise again, schemes need to ensure they have a clear justification to present to the Pensions Regulator. This should include a long-term plan for how they are going to manage the risks they are exposed to, given an employer’s ability to fund a scheme in the long term. The good news is that there are a number of options for schemes to do this, including increasing non-cash funding and hedging risks.

“Some commentators are calling for gilt yields to be smoothed to help alleviate the current pressure on cash as a result of increased deficits. Smoothing can mask the true position and produce unintended results. Whatever the position, companies should consider the current suite of approaches to manage cash, including recovery plans and methods used to set the discount rate.”

The survey also enquired as to what else the pension plans were doing to combat the risks of shortfall and deficit and of course longevity risk is one of the most obvious long-term issues that these defined benefit schemes face. Longevity risk is slated to become the number one concern of pension plans and funds in the coming years, so it is a little surprising and perhaps concerning to find that as few as 22% of the surveyed pensions said they had considered hedging longevity risk.

Just yesterday reinsurer Swiss Re repeated its calls for a liquid capital market in longevity risk, which if it existed might make pension schemes sit up and take a little more notice of this growing risk and the need for them to prepare to hedge against it. Longevity risk will likely affect all 98 of the pension plans that PwC surveyed and it is up to the market to better educate these schemes to make them aware of the risks and the potential solutions so that hedging longevity risk at least enters their consideration set.

Read the full press release from PwC.

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