Report Claims Public, Private Employer Pensions Have Under-Reserved for Longevity Risk

(October 24, 2011) — With pension plans not putting aside enough money to account for the risk of people living longer than expected, funds are growing increasingly focused on longevity risk, a new report by Swiss Re has found.

The report by Swiss Re — which is aiming to push pension plans and insurers to buy protection against this risk — found that many Canadian public and private employer pension funds have under-reserved for longevity risk. The failure among schemes to appropriately reserve for longevity risk is an underestimation that could have a drastic effect on pension funds’ liabilities, the firm noted.

The report, “Longevity risk and protection for Canada,” identified roughly $1 trillion of pension assets and immediate annuity reserves as “at risk” in Canada as of 2010. Furthermore, the report found that insurers can work in partnership with reinsurers to develop robust approaches to mitigating longevity risk.

“Increasing life expectancy is one of the greatest achievements of the 20th and 21st centuries, however, pension funds and annuity providers may have underestimated how long their members and policyholders will live,” said Kurt Karl, Head of Economic Research & Consulting at Swiss Re. “To protect their solvency and ensure they can continue to provide retirement income, these entities can now transfer some of their longevity risk.”

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The report found that global pension assets exceed roughly $20 trillion, including about $1 trillion in Canada.

Active management of longevity risk by pension funds and insurers with annuities is likely to increase, the report concluded. More specifically, the market for longevity risk solutions — including buy-outs, buy-ins, longevity re/insurance, longevity swaps, and longevity bonds – is expected to grow to about $180 billion to $315 billion in total assets transferred by 2020.

The report stated: “Longevity is a systematic risk — it is undiversifiable. Whereas buying 10 corporate bonds provides diversification and thus some protection in the portfolio against default risk, aggregating pension funds through mergers would provide no diversification benefits from longevity. Systematic risks may not be diversifiable, but they can be hedged or transferred. Transferring risks obviously will not diminish the societal problem of providing for an aging population, but spreading longevity risk to a wider range of market participants will allow society to more easily absorb the risk.”

While the Swiss Re report focused on longevity risk among Canadian plans, the concern over people living longer than expected is widespread among schemes. A growing number of UK pension plans have expressed concern over the increasing longevity of plan members, according to MetLife’s Pension Risk Behaviour Index Study. The study was conducted through interviews with 89 trustees and sponsors of UK defined benefit (DB) pension funds. The study focused on 18 distinct investment, liability, and business risks and sought to better understand how UK DB schemes viewed the importance of such issues in a changing economic landscape.

The report statef that “whilst improvements in life expectancy are good for individuals, Longevity Risk is a key driver of the pressure that DB schemes face and its financial impact on DB schemes should not be underestimated.”

In spite of the fact that pensioners may not begin to outlive their life expectancy in the immediate future, “from a valuation and accounting standpoint there will be an immediate increase in the value of the scheme’s liabilities. Where the sponsor absorbs the Longevity Risk, this may require higher levels of contribution to the scheme,” the report concluded.

In January, as part of its risk-management strategy, the Pension Insurance Corporation (PIC) reinsured $799 million of longevity risk to manage risk and better compete for new business.

The move reflected the efforts among insurers to free themselves from risk as a result of pensioners living longer than expected. According to some forecasts, more than $24 billion worth of pension risks could be passed on to insurers this year. PIC has said its transactions indicate the insurer’s desire to focus on risk management and on the efficient allocation of capital.

The reinsurance by PIC was undertaken in two separate transactions, taking the amount of longevity exposure which the firm had reinsured to 70% of its total, or $3.7 billion. “These transactions build on our active longevity reinsurance policy and allow us to efficiently manage our capital,” said Pension Insurance Corporation chief financial officer Rob Sewell in a statement. “We look forward to further transactions of this nature, backing up our promise to bring safety and security to pension fund members’ benefits. We also look forward to writing further transactions this year, in what we expect to be a busy year for the pension insurance market.”

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

In his inaugural speech, Mark Hyde Harrison, the new Chairman of the National Association of Pension Funds (NAPF), noted that defined contribution (DC) pensions in the UK are inefficient and wasteful.

(October 24, 2011) — The new National Association of Pension Funds (NAPF) chairman Mark Hyde Harrison has asserted that the pension system in the UK’s private sector is ‘significantly flawed’ and will leave too many savers with measly retirement pots.

In his inaugural speech, the new chairman of the UK’s leading pensions body warned that the structure of ‘defined contribution’ (DC) pensions in the UK are inefficient and wasteful. “The current system is a mess, and what’s really worrying is that over the coming years millions of people will be brought into it,” he said in his speech. “We need a radical rethink of the way we ‘do’ pensions in the UK. If we don’t, then too many people will save into a pension only to find themselves shortchanged in their retirement.”

Hyde Harrison added: “We must move from today’s significantly flawed structure to a world of large, efficient, well-run and low cost pensions which are run in the interests of savers.”

In the UK, DC pensions have largely replaced final salary, or defined-benefit (DB), pensions in the private sector. According to the NAPF, their importance is set to balloon ahead of new government rules that will force all workers to automatically enroll into the system.

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As outlined in a release by NAPF, Hyde Harrison noted four major flaws with the current DC system in the UK:

1. DC pensions are too small scale, and too numerous. This creates massive inefficiencies and leads to higher costs, weak governance and poor administration.

2. Information about costs and charges is far too opaque. If the pensions industry was more upfront about them then charges could be driven down.

3. Savers’ interests are overlooked because employers and pension providers are not really batting for them, which can impact investment returns and the governance of a pension.

4. The average worker has too many ‘pots’ and finds it overly bureaucratic and difficult to pool them together. This can leave unwatched pensions languishing in low performing funds, or being eroded by high charges.

Looking ahead, Hyde Harrison asserted that the future of DC pensions would be strengthened by converting schemes into Super Trusts, or pensions that run immensely larger in scale. “They would allow, for example, a small employer to join an existing pension structure with 1,000s of other members, rather than setting up its own small-scale scheme,” NAPF stated in a release.

Hyde Harrison’s statements about the flawed nature of private sector pensions in the UK follow a new report on the other side of the Atlantic, which asserted that built-in economic efficiencies enable New York City public pensions to do more with less dollars. The report issued by New York City Comptroller John Liu showed that the city’s public pension plans are more cost-effective for employees compared to the private sector, with efficiencies derived from investment expertise and leverage as institutional investors.

The study showed that New York City’s pensions provide retirement income at roughly 40% lower cost than individual accounts, paying equal retirement benefits as those used in the private sector but at a significantly lower cost while enabling the city’s pensions to “do more with less dollars.”

“Defined benefit plans have enormous economic efficiencies over defined contribution plans,” said the report — titled A Better Bang for New York City’s Buck — by the National Institute on Retirement Security (NIRS) and issued by Liu.

The report by the Washington, DC-based non-profit organization demonstrated that DB savings are derived from three sources:

1) Superior investment returns: The pooled nature of assets in a DB plan results in higher investment returns, partly based on the lower fees that stem from economies of scale, but also because the assets are professionally — not individually — managed.

2) Better management of longevity risk: New York City’s DB plans save between 10% and 13% compared to a typical DC plan.

3) Portfolio diversification: The ability to maintain portfolio diversity in the city’s DB plans saves from 4% to 5%.

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742