New longevity assumptions that increase the life expectancies for pension plan cohort members, which ultimately increase pension plan accounting liabilities, will not affect the cost of insurance and reinsurance capacity for longevity risk transfer, according to Prudential.
In the past the calculation of accounting liabilities for pension plans has been based on outdated assumptions about longevity risks and mortality rates. However the large global insurers and reinsurers that provide capacity to back transactions providing longevity risk transfer have already been taking these into account.
It’s testament to the rigorous approach that insurance and reinsurance companies apply to analysing and modelling the risks associated with pension plans, particularly assumptions surrounding mortality rates and longevity expectations.
Changes in mortality tables, the actuarial-based forecasts for in-country death rates, can have a dramatic effect on the actual liabilities that a pension plan or fund could face in the future. As mortality rates change it typically implies life expectancies increase, resulting in growing longevity risk for the plan.
Many pensions have been slow to adopt the latest thinking about mortality rates and cohort longevity, resulting in them underestimating their liabilities. When they do adopt the latest figures the liabilities can jump, however the costs of insurance or reinsurance capacity to hedge the longevity risk will not increase.
According to Amy Kessler, Prudential’s Head of Longevity Risk Transfer; “The changes in pensioner mortality tables in the U.S. will add approximately 6% to pension liabilities reported on corporate balance sheets but will not increase the estimated cost of a buy-out or any other insurance or reinsurance solution for pension risk because these longevity expectations were already factored into insurer and reinsurer pricing.”
In the world of pension liabilities 6% is a very big number. U.S. pension plans have trillions of forecast liabilities in payments they will have to make to pensioners. Rating agency Moody’s said last year that the latest mortality table update in the U.S. would add over $100 billion to pension fund liabilities.
As new mortality tables change and increase longevity expectations for pensioners, so the funding gap between assets held by U.S. pension plans and their liabilities grows. As a result it is expected that increasingly insurance and reinsurance solutions will be called on, from buy-outs that transfer the entire pension plan risk to another party, or specific longevity swaps and hedges that offload the tail risk.
Prudential explained in a recent report; “Interest in pension risk transfer continues to intensify among corporate sponsors of U.S. defined benefit (DB) plans, as plan sponsors are looking
for ways to reduce both balance sheet liabilities and funded status volatility.”
The appetite for pension risk transfer solutions is increasing in the U.S. and there is an expectation that longevity risk transfer solutions will also begin to be used, especially Prudential explains “against the backdrop of new mortality assumptions that will increase DB plan liabilities, as well as increasing PBGC premiums.”
Still, U.S. pension plans accounting of liabilities still largely underestimates the impact of longevity risk. But as Prudential explained, this won’t affect the cost of longevity insurance or reinsurance solutions, given the increased risk has already been taken into account.
That should be encouraging for U.S. pension plans facing that see their expected funding shortfalls rise as a result of adopting the new mortality tables. Eventually the U.S. market is expected to embrace longevity risk transfer, as the risk is not going away and is only going to grow and increase liabilities and shortfalls.
With longevity swap solutions becoming more efficient, making it easier for pensions to access sources of insurance or reinsurance capacity, conditions for pension risk transfer are perhaps as good as they get.
That should stimulate growing interest in these solutions. Which will ultimately increase the amount of risk transferred and eventually begin to soak up the longevity reinsurance capacity that is currently available, perhaps making more room for ILS and capital markets players to participate.
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