The cost of longevity risk has increased by 50 and could rise even higher as negative real yields becomes the ‘new norm’ says Hymans Robertson.
The actuarial firm says a 1 year increase in longevity adds 4.5 per cent to the cost of paying a member’s pension, compared to 3 per cent 12 years ago. Hymans says low interest rates have pushed liabilities up 50 per cent over past 12 years and argues the risk of yields staying low or getting lower for longer has increased following Brexit. Total defined benefit pension liabilities now stand at £2.3 trillion says Hymans.
Hymans Robertson chief investment officer Andy Green says: “When interest rates were much higher, if people lived one year longer than expected, this increased the cost of providing their pension by around 3 per cent. However, with real yields on index-linked gilts now below -1 per cent, more money needs to be held today to pay a year’s pension in 25 years’ time than is needed to pay next year’s pension.
“Consequently a one year change in life expectancy is now more likely to add 4.5 per cent to the cost of paying a pension for someone’s lifetime. That’s a 50 per cent increase in longevity risk.
“In combination with the increase in liabilities, there has been a 125 per cent increase in like for like longevity risk in pound terms.”
Hymans Robertson head of risk transfer solutions James Mullins says: “This increase in the cost of longevity risk comes at a time when, due to schemes maturing, they’ve been dialling down their exposure to investment risk. This means that longevity risk now represents a larger risk than ever before for DB pension schemes. We will therefore inevitably see longevity risk management move higher up the agenda for those running DB schemes.
“This is right. Schemes should be seriously considering reducing their exposure to members living longer. Longevity solutions such as buy-ins and longevity swaps will be more relevant to risk management plans than ever before. The good news is that prices for these types of insurance have not been adversely affected by the market shocks following the Brexit referendum result. So longevity risk has leapt up for DB pension schemes but the cost of insuring against this risk has remained nicely competitive.”
“While longevity insurance using longevity swaps has played an important role in the de-risking plans of some of the UK’s largest schemes, smaller schemes have found the costs prohibitive. Fortunately the longevity swap market is innovating to make longevity hedges more accessible and affordable to smaller schemes too.”