Research

Apocalyptic demography? Putting longevity risk in perspective

Current life expectancy depends very much on demographic factors, particularly lifestyle, and varies from scheme to scheme, i.e. it is scheme specific. It is therefore very important that companies understand where their scheme sits in the population of pension schemes as far as life expectancy is concerned.

Executive summary

Life expectancy differs from person to person, population to population and pension scheme to pension scheme. So a company's scheme members' mortality experience will be unique. Age is its dominant determinant, but life expectancy is influenced by other factors including gender, geographical location, social class, pension size and occupation. In order to help company finance directors understand the effects that these factors have on their scheme members' mortality, Professor David Blake and John Pickles, from the Pension Institute at Cass Business School look at issues that shape current life expectancy, and then separately, the trends in the rate of improvement in life expectancy.

Current life expectancy depends very much on demographic factors, particularly lifestyle, and varies from scheme to scheme, i.e. it is scheme specific. It is therefore very important that companies understand where their scheme sits in the population of pension schemes as far as life expectancy is concerned.

Blake and Pickles also look at the improving trend in mortality. UK life expectancy has nearly doubled over the past 150 years, increasing by 2-2.5 years a decade on average. These improvements have consistently exceeded official projections. Finance directors need to understand the assumptions underlying their pension scheme's life expectancy projections. To help them, the authors present a range of views on future life expectancy. This range reflects both the uncertainty of life and the lack of a commonly accepted forecasting model. Finally, they consider how one might quantify the risk in their mortality assumptions by looking at the impact varying the assumptions has on your scheme liabilities. For example, the Pensions Regulator estimates that two years of extra life could add 5per cent to the value of a defined benefit plan's liabilities. Finance directors need to decide whether the longevity risk in their pension scheme is material to their organisation and, therefore, of strategic importance. To that effect, Blake and Pickles introduce two categories of longevity risk (idiosyncratic and aggregate, see Section 4.1, pg 31) and discuss their financial implications. If a scheme's longevity risk is material, one might want to seek specialist advice as to how they might manage it. Options include changing benefits, laying off some of the risks or buying out the pension liabilities.

In a consultation document issued in February 2008, the Pensions Regulator has indicated what it considers good practice when choosing assumptions for defined benefit pension schemes, with a specific focus on mortality, and proposes to exercise greater scrutiny where that is not met. Inevitably finance directors will need to discuss longevity assumptions with their actuary and to assist them in these discussions the authors have devised a checklist (see pg 53), focusing on three key areas: current life expectancy, projected life expectancy and longevity risk.

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