“Life and death. At some point we’re gonna leave this world. Do I know when? Absolutely not.” - Terrell Owens
After the superbowl it seemed fitting to quote a former Philadelphia Eagles player. Estimating how long we’re going to live is as old as (intelligent) life itself. In the world of actuarial science, this means predicting the amount a firm will need to pay out to pensioners. Recent data readings have shown that the projected rate of growth of life expectancy was potentially too high. So what does this mean for pension schemes?
The new data readings are now feeding into pension scheme liabilities and could have large impacts on company solvency as well as investment strategy: if your obligations are lower than you thought, you may no longer need all the bonds that you were holding to meet the expected pensioner payments. For instance, a one-year reduction in life expectancy could reduce the value of liabilities for a FTSE 100 pension scheme by around 5% (according to LGIM calculations).
Controlling for all variables in what’s driving the decrease in life expectancy is very difficult but there is some evidence that NHS spending is not increasing as fast as medical costs, partly as a result of austerity measures. Other factors include the virulence of ‘flu strains and the morbidity of heart disease and dementia.
A one-year reduction in life expectancy could reduce the value of liabilities for a FTSE 100 pension scheme by around 5%
Graham Moles and the team also recently highlighted that pension scheme liabilities were reducing as a result of transfers out of schemes due to pension freedom legislation. These changes, as well as those due to mortality, won’t feed through to the market instantly. Schemes update their liabilities typically in line with a triennial valuation cycle (sometimes more frequently) so this is likely to be something that plays out over the coming years. LCP have estimated that the impact of updating to the latest mortality table could change liabilities by around 3%. Depending on which mortality table was used to calculate the liability projection this may be larger. It is also dependent on the persistence of the recent trend and individual schemes’ sensitivity to changes in mortality (schemes with older members would see a lower impact on their liabilities).
These changes could help explain some of the improvements seen in funding levels (see the chart below). Higher funding levels and lower liabilities could have a number of potential impacts. If trustees look to lock in their improved funding position and further de-risk their schemes, this should support bond prices and reduce equity allocations. On the other hand, if schemes have bought more bonds than required to hedge their now smaller liabilities, then this could be negative for bond prices as bonds are sold. One to keep an eye on…