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Disclaimer: Views in this blog do not promote, and are not directly connected to any Legal & General Investment Management (LGIM) product or service. Views are from a range of LGIM investment professionals and do not necessarily reflect the views of LGIM. For investment professionals only.

Reports of mortality’s death have been grossly exaggerated

At first glance, the mortality tables released this year highlight a continued trend of falling life expectancy. What does this mean for pension schemes and markets?

This isn’t the first time we’ve written about the wide-ranging implications of declining life expectancy. Yet what is different this time is the additional kicker placing more weight on recent data.

This made the headlines and has particular implications for defined benefit (DB) pension funds. Of course, what goes up can come back down, and some have pointed to flu episodes over the past few years being a significant contributor to the changes.

Whilst the magnitude of the change in terms of what it means for liabilities will vary, it seems clear that the direction of travel is certainly lower in terms of their present value, and shorter in terms of their duration.

What does this trend mean for DB pension funds?

We have crunched the numbers using the generic Continuous Mortality Investigation (CMI) mortality tables. We assumed a standard three-year valuation cycle, so compared the latest 2018 tables to the 2015 tables. The results are shown in the chart below in terms of the effect on the typical cashflow profile of a DB scheme. The results combine two changes: a change in the allowance for future improvements; and a change in the base table, reflecting estimates of current mortality rates.

As a percentage, the impact is far greater at longer maturities, as laid out clearly in the next chart.  

Based on LGIM’s stochastic longevity model, we estimated a c.4% fall in the present value of liabilities. This broadly translated to a 1-in-10 shock over the three-year period. So whilst the changes are headline grabbing, this hasn’t actually been a rare movement in absolute terms.

DB pension funds have become better funded and better hedged recently. Longevity risk was historically lost in the noise of equity markets and interest-rate moves, but is now moving to the foreground as equity exposure has gone down and hedge ratios up. The theme is similar to one we recently wrote about the consumer price index (CPI).

Strategically, we expect greater focus will be placed on risks such as longevity in future, and have debated at length whether there is a correlation between rates markets and longevity. As yet, we do not have a sufficiently high-conviction view to say either way: while traditional wisdom might point to higher yields going hand in hand with higher longevity, in Japan it is the other way round. Nonetheless, expect more discussion, more analysis, and probably more longevity hedging.

What does this mean for markets?

We estimate that the changes theoretically mean there could be c.£4.5 billion of selling of 50-year gilts relative to 30-year gilts.

How material could that kind of flow be to markets? Obviously it would be very material if it was carried out in short order, but in reality it is likely to be more drip fed. To put this in perspective, we looked at Debt Management Office (DMO) issuance from calendar year 2016 to date in 2019:

  • Roughly £50 billion of 30-year issuance of both linkers and gilts (defined by 2046 to 2049 maturities)
  • Roughly £50 billion of 50-year issuance of both linkers and gilts (defined by 2065 to 2071 maturities)

This is around £15 billion per annum at each maturity. So £4.5 billion of selling, even if drip fed, certainly has the capacity to make a difference and send curves steeper.