Highlighting the importance of measuring, tracking and understanding longevity risks faced by pension funds, Danish pension fund manager ATP Group disclosed a loss in its pension activities mainly due to longevity risk discovered after an annual update of its members life expectancies.
The experience of pension fund ATP is a good example of the need for longevity risk hedging strategies at any fund exposed to increases in life expectancies of its members. ATP said that in the first-half of 2013 its pension activities posted a loss of DKK1.2 billion (approx $220m) mainly due to an update of ATP members life expectancy.
This annual update of life expectancy for members of a pension fund is a normal process for many pension funds as it allows them to forecast any potential shortfalls due to longevity risk. Pension funds tend to use life expectancy measurements and statistics, often government data, to work out whether they should expect their members to live longer.
This years update appears to have been particularly big for ATP. It updated its longevity model with new international data from the OECD which meant that the forecast for Danish life expectancy was adjusted upwards. It said that the annual update this year added DKK2.5 billion (approx $450m) to its provisions, which is equivalent to 0.5% of guaranteed benefits, which led to the loss on pension activities.
What is really interesting is that the life expectancy increases for Danish citizens is actually very small, for women, life expectancy increased by just under 1 month, while the increase for men was approx. 1.5 months, which shows that even a small increase in life expectancy can result in a large financial burden.
ATP Group do not hedge this longevity risk, rather they increase provisions for making benefit payments for the longer projected lifespans. Many pension funds undergo an assessment of the life expectancy of their members each year and they can expect to find provisions increasing as longevity is expected to increase.
This once again shows the need for a market approach to hedging longevity risk, providing a liquid way for pension funds, and others exposed to life expectancy increases, to hedge and transfer their longevity risk.