Longevity is the most challenging risk for pensions, says report

Could apocalyptic demography undermine the financial viability of your defined benefit scheme? By Tim Cooper, editor, e-magazines, CIMA.

A leading pensions economist has criticised actuaries for not making the risk of increasing longevity clear enough to pension schemes and the companies that run them.

Speaking at the launch of a new report from the CIMA Pensions Advisory Group, David Blake, professor of pension economics and director of the Pensions Institute at Cass Business School, said: ‘I blame the actuaries in part for this, for having a black box approach to longevity and mortality, for having a little table that they use that’s not readily understood by trustees or plan sponsors.’

The result has been a serious underestimation of the increases in life expectancy. Final salary pension deficits and liabilities have therefore been much worse than previously realised.

Professor Blake said: ‘We are now beginning to recognise longevity as one of the key risks that have to be quantified, analysed and managed alongside interest rate risk and inflation risk. Once you’ve hedged inflation and interest risk - which is what some of the larger pension plans are doing through things like interest rate and inflation swaps - longevity risk becomes a relatively much bigger risk. Finance directors need to become aware of this and think about what they’re going to do with it.’

Quantifying risk

Professor Blake is one of the authors of the CIMA report – entitled ‘Apocalyptic demography: putting longevity risk in perspective’ – together with John Pickles, research fellow the Pensions Institute.

The report tracks rapidly increasing mortality rates in a range of countries. Average life expectancy in industrialised countries has nearly doubled in the last 150 years, rising on average by two years every decade for men and two and half for women.

Professor Blake said: ‘From a liability perspective this is a very significant figure. We estimate that a 5% shift in pension liability would cost the UK around £45 billion in long-term liability.’

The report is aimed at helping finance directors measure the risk of rises in longevity to their pension scheme. It helps them measure the wide range of factors in their company that could affect longevity, the general trends in life expectancy and the assumptions that underlie their scheme’s projections.

It presents a range of views on future life expectancy, and a guide to quantifying risk in mortality assumptions by looking at their effect on liabilities. For those who find that the longevity risks in their scheme are material the report then goes on to suggest ways of managing them.

Keith Barton, chairman-elect of the Association of Consulting Actuaries (ACA), said of the comments in this article: 'Actuaries are not simply using a black box approach. They are engaging with their clients on this important topic. The problem with longevity is not about knowing how long people are living at present - that's easy - the problem is knowing how fast mortality rates will improve in the future and what allowance to make for this. Such allowances are by their nature subjective. For years actuaries have been including allowances for future improvements in their calculations. With hindsight it may turn out that a higher allowance should have been used - but no-one at the time was saying that they were wrong or suggesting alternatives. It is quite wrong to suggest that actuaries have been ignoring longevity improvements.'

Read the Pensions Advisory Group’s reports on corporate risk and longevity risk.  

May 2008

Back to Insight front page

What did you think of this article? Email tim.cooper@cimaglobal.com.