A new survey performed by Mercer, the retirement specialist arm of brokerage Marsh & McLennan, found that UK defined benefit pension funds have continued to increase their life expectancy assumptions, leading to growing longevity risk.
Mercer’s 2014 Valuations Survey shows that on average UK defined benefit pension funds are increasing life expectancies for the over 65’s (those of pensionable age) by 6 months. Trustees of defined benefit pension schemes are now assuming that, on average, women aged 65 will live an additional 25 years and six months to a total age of 90 years and six months, while men aged 65 are assumed to live an additional 23 years and four months reaching a total average age of 88 years and four months. That’s up by around 6 months since the 2011 survey.
Mercer’s survey analysed data from 202 UK defined benefit pension schemes, which between them have £59 billion in assets and over 670,000 members (deferred, active and pensioners).
Any increase to life expectancies increases the liabilities that a pension fund faces. Mercer estimates that, for every month of increased life expectancy, the liabilities of a defined benefit pension fund with £100 million in liabilities will increase by about £300,000. A scheme increasing the life expectancy of their members by six months would increase the overall cost of providing those pensions by £1.8 million.
“Member longevity is one of many critical risks impacting the financial health of a DB pension scheme, but it’s very hard to anticipate with any confidence. It’s possible there is no end in sight to the increases,” commented Dr. Deborah Cooper from Mercer. “Whether the money to pay for the increases comes from asset performance or company contributions, it’s a further ratcheting up of the financial pressure on companies as their exposure to risk stretches over a longer period. Consequently, trustees and employers need to look for ways to manage the financial consequences of increased longevity.”
Longevity risk transfer, through hedging mechanisms such as swaps, insurance, buyouts and partial buyouts, are increasingly an option to help pension funds deal with increasing life expectancies. As we wrote just the other day, U.S. pension funds face an increase in longevity assumptions later this year with the introduction of new actuarial mortality tables. UK pension funds tend to value their liabilities much more frequently, but with life expectancy increasing across all pension markets growth in longevity hedging is likely to be seen.
Dr. Cooper explained; “Historically, valuing pension schemes was done triennially – with more approximate reviews being carried out annually – but as DB schemes have become a more onerous burden, this has proved insufficient for many sponsors and trustees. It’s encouraging to see that over 54% of trustees are saying that they are monitoring their funding level at least quarterly – 8% do it on a daily basis, so are able to react more quickly to market changes. However, that still leaves a large proportion of schemes where risks are not actively managed.”
Any increase in life expectancy results in higher longevity exposure for pension funds. Closing down defined benefit pension plans has been the preferred option in the past, but as longevity risk begins to impact more widely, with life expectancy increases are expected to speed up, longevity risk transfer is likely to become much more prevalent and reinsurance and hedging tools likely to increasingly feature.