 Financial institutions need multiple data sources for their modelling, but with more variables to consider it is becoming increasingly difficult to predict the trajectory of life expectancy and longevity improvements; even for demographers and actuaries.
The latest Pensions Buyouts and Longevity Hedging report from Clear Path Analysis looks at the views of UK and European trustees, sponsors, advisors, asset managers and regulators on longevity hedging and pensions buy-outs.
A House of Lords inquiry, by the Committee on Public Service and Demographic Change, has revealed that longevity expectations are to increase further with half of those born after 2007 now expected to live to over 100. Furthermore, the number of people aged over 65 is set to increase 51% by 2030.*
Dr Aubrey de Grey, Chief Scientific Officer, SENS Foundation highlights that: "Mortality rates will continue to decline and longevity will increase at a rate of about 2.5 years per decade, in life expectancy at birth.’ For pension schemes life expectancy continues to vary dependent on trustee profile but this has a direct impact on how they are managed."
However longevity isn’t the only driver for trends in the de-risking space. First, market volatility has presented problems as well as opportunities. Second, quantitative easing has been a factor in growing liabilities and pension scheme deficits have ballooned to £621 billion.** Yet, many have been preparing their data throughout 2012 and just like BAE’s £3.2bn longevity swap in February, there is an expectation that this year could see a lot of transactions as the larger schemes get ready to de-risk.
Growing regulatory pressures, such as Solvency II, and the complexity that surrounds inflation rates and longevity has meant that smaller pension schemes are daunted by the de-risking options they face. Funding shortfalls have also made it more difficult for the smaller pension schemes and providers have to be particularly alert to new analysis of data on longevity, especially for buy-ins and buy-outs.
However, Kelvin Wilson, Director, Pension Risk Solutions, Grant Thornton LLP notes: “Buy-outs tend to work for schemes at the smaller end of the scale, where the price differential isn't as significant, at 30-40 %, the financial impact for the smaller schemes is less.”
It is generally accepted that trustees of larger multinational schemes are better educated in the longevity market place whereas for the smaller schemes it often comes down to an issue of priority.
Eva-Maria Keller, Product Manager Longevity at Deutsche Boerse states that: “Prioritisation issues are similar for bigger and smaller schemes but the complexity is more difficult to handle for smaller schemes. However, the different solutions that currently exist to hedge longevity risk seem to be transparent for market participants, especially smaller schemes. They simply don’t know how easy it can be.”
She goes on to note that in advising clients: “Data is a key issue. If you consider hedging your longevity risk, it is very important to understand your portfolio and to have a clear view of the specific life expectancy of your pensioners compared to the population. This will enable you to judge the advantages of a standardised longevity hedge.”
Wilson echoes this while stressing the importance of planning within realistic timeframes: “A lot of my clients are putting in triggers or flight paths which effectively mean they monitor their positions against a set criterion to determine when they are going to engage in a transaction. It then becomes a planning and monitoring exercise to take advantage of market opportunities.
Flight paths should be used to manage risks and improve the funding position of schemes within agreed boundaries. You have to take risk out when funding improves and consider re-risking within controlled boundaries when funding deteriorates.”
Peter Hughes, Partner at Travers Smith LLP added: “When entering into any derivative or insurance contract, a trustee can be forgiven for feeling that it is trying to read the future in a crystal ball.
In structuring the transaction trustees will need commercial advice on the actuarial model underlying the contract. This is the heart of the transaction. The trustee needs a clear understanding of different sensitivities implicit in the model and the payments required under the contract in different future longevity scenarios.”
To view the report and for more information please click here.
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