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Longevity risk over-valued, but access to risk transfer growing: Club Vita


Pension fund longevity exposure is over-valued, resulting in a potential for over UK£25 billion to be wiped off the collective deficit of UK defined benefit pensions if more accurate longevity assumptions were used, according to specialist longevity risk information provider Club Vita.

Longevity assumptions, or the underlying data and projections on life expectancy and longevity, that pension funds use when calculating their liabilities could be more accurate, Club Vita believe, which would have the effect of reducing liabilities, but could also help to make longevity swaps, insurance and reinsurance more accessible for pension schemes which need risk transfer the most.

Douglas Anderson, Founder of Club Vita, commented; “With rock-bottom interest rates causing pension deficits to swell, trustees and sponsors of defined benefit pension schemes need to avoid unnecessary margins in assumptions. Companies with schemes facing record funding deficits in 2017 valuations will be feeling the heat. They, and scheme trustees, should look at whether they’re taking an unnecessarily prudent approach. It could be distorting important decisions on the future startegy of their schemes.”

By using Club Vita longevity curves pension schemes can benefit from a more accurate estimate of future liabilities, the provider said, with the majority of its users seeing a reduction.

Anderson continued; “When we take on a new scheme, on average there’s an over-valuation of liabilities of around 1%, with several schemes enjoying far larger reductions to their deficits. The 1% average reduction is equivalent to continuing to pay everyone’s pension for 4 months after they have passed away. If the same pattern was seen across all the UK’s defined benefit pension schemes, then deficits could fall by £25bn by adopting Club Vita’s methodology. You might have expected that bigger schemes would be better at assumption-setting than smaller schemes but that’s not so, with several £1bn+ schemes overestimating liabilities by substantial amounts.”

There are a number of factors that have caused this over-valuation of longevity risk in UK pension schemes, Anderson said.

He explained; “Having helped almost 250 schemes get a better handle on longevity risk over the last decade, we’ve observed three main causes. First, using final salary (as well as postcode) as a predictor of longevity refines the valuation of mid-sized pensions. Under the traditional approach, you don’t know whether a typical £5,000 annual pension relates to a long-serving, low-salary person or a short-service, high-salary person – two people would have very different life expectancies.

“Second, the data underpinning Club Vita’s survival tables is fresher than the CMI tables typically used by schemes and captures heavier mortality in recent years. For example, the 2016 VitaCurves data is based on 2012-2014, compared to CMI S2 tables which use data from 2007. Finally, when adjusting “standard” CMI tables, there is a natural behavioural bias to err on the side of caution in the face of uncertainty. VitaCurves capture a wider spectrum of diversity of our population than CMI tables (shown by the 10 years range of life expectancies rather than 5 years for CMI), reducing the need for subjective, manual adjustments.”

“Naturally, the ultimate cost of a pension scheme will be determined by how long its members actually live. But assumptions made today really do matter for such long duration commitments. The confidence that trustees gain from more insightful longevity assumptions does change behaviours, affecting members’ benefits, their security and businesses’ ability to invest.”

A reduction in liabilities could help some of the most longevity risk exposed pension schemes access insurance and risk transfer, with longevity swaps more affordable as they dial down the over-valuation. The closer to fully-funded a pension becomes the more affordable and accessible longevity risk transfer and with the proliferation of platforms to help smaller longevity swaps be executed the prospects look promising.

Of course dialing down the level of longevity risk would also make longevity risk transfer less necessary for some pensions, but with so many so exposed the pipeline for longevity swap deals backed by global reinsurance capacity is expected to continue.

Anderson noted that longevity hedging is no longer the preserve of larger pension schemes, with transactions now accessible by smaller pensions seeking to offload longevity risks into the reinsurance markets.

“Rightly, we have seen longevity management move higher up schemes’ agendas. With DB schemes maturing and investment risk being dialled down, longevity is now a bigger risk than ever before. Fortunately, hedging out the uncertainty in future longevity trends may be more affordable than many trustees think. This is particularly relevant now that longevity insurance is available to smaller pension schemes through innovations like Club Vita’s VitaHedge service. Until fairly recently, insurers were only confident to offer attractive prices to the biggest schemes, but that’s now starting to change. Given a combination of increasing costs of longevity risk and improved access in the market, we expect many more schemes to take proactive steps to manage longevity risk in 2017,” he stated.

See details of recent longevity swaps and longevity reinsurance transactions in our Longevity Deal Directory here.

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