Changes to life expectancy driven by post-pandemic expectations as well as the latest Continuous Mortality Investigation (CMI) mortality projection model could have a significant impact across areas of defined benefit scheme management. For example, any scheme that adopts the most recent CMI model could see their assumed member life expectancy reduce by over half a year relative to a previous valuation – equivalent to a 2-3% reduction in liability values. In this edition of the mini-series, we explore a few of the areas that could be affected.
01
Trustees and sponsors carrying out a triennial actuarial valuation of their scheme this year most likely haven’t had to examine life expectancy in any detail since their last actuarial valuation three years ago. We expect most to adopt a reduced view of life expectancy, such as that implied by the 2022 CMI projection model, in the light of post-pandemic mortality experience. In doing so, they will be releasing funding reserves and will find they are better funded than expected. This could cut short recovery plans, lead to even larger surpluses, and/or provide the opportunity to de-risk. In any event, it will put more focus on long-term funding plans but also increase sponsor concerns about trapped surpluses (exacerbated by the significant rise in interest rates and gilt yields that has led to the improvement in many schemes' funding positions) – see next section.
02
As above, many schemes will now be paying more attention to their long-term funding plans. Some schemes may be able to bring forward their established de-risking ambitions, whether that’s by reducing investment risk or looking towards the insurance market. For many schemes, the longevity slowdown coupled with the significant rise in gilt yields may have precipitated trustee and sponsors discussions over the right long-term strategy – is insurance truly the best outcome for members or could a well-managed run-on provide more equitable benefits to members and the sponsor? Or a combination of both?! Some schemes will rightly continue to target an insurance solution, for example where the sponsor covenant is less certain. Others however may conclude there is no rush to approach a busy insurance market, especially if running the scheme with a surplus, either indefinitely or for a period, provides the scope for members to benefit (for example through discretionary pension increases) and sponsors to get something back (for example by covering running expenses or new defined benefit/defined contribution accrual contributions). In any event, shorter life expectancy will mean shorter cashflow profiles, meaning liability-driven investment (LDI) and cashflow-matched strategies may be out of sync and need refreshing.
03
For those targeting an insurance solution, they may find that the evolving view of longevity is already priced-in to bulk annuity and longevity swap pricing to a large extent. In other words, trustees and sponsors won’t necessarily experience a jump in their estimated buyout funding level at their next valuation and won’t necessarily find insurers quoting for a cheaper bulk annuity price than expected (depending on how estimates are tracked between valuations). Insurers are, however, naturally slower to reduce the price of annuities and longevity swaps when life expectancies are reducing, meaning there is still potential for some further price reductions relating to longevity, particularly if pandemic-induced experience continues for longer. Longevity and gilt yields are not the only factors that influence annuity pricing – credit spreads, competitive forces in the market and regulatory changes have all recently played a part. Insurance pricing is attractive at the moment, and with the right guidance schemes can navigate the busy market effectively.
04
From a sponsor perspective, reductions in life expectancy will get recognised as a ‘assumption gain’, improving the balance sheet asset or reducing the balance sheet liability. Because of this, we expect most sponsors to be considering life expectancy with advice from their actuary if they haven’t already. Whether this flows through the profit and loss account immediately or is amortised over future years depends on the territory and accounting standard being used. From discussions with auditors, we know they are braced to see such changes come through in financial statements.
05
One potentially less obvious implication of reduced life expectancy is that it implies less generous member options. For example, if a reduced assumption for life expectancy is incorporated into a scheme’s next regular factor review, it could reduce fair value transfer value and cash commutation terms offered to members by up to 3%. In ordinary circumstances, this could be noticeable to members. However, at the current time this is overwhelmingly shadowed by the significant recent increase in gilt yields which alone could reduce implied transfer value and cash commutation terms by 30% for example. As a result, we expect trustees and sponsors to be relatively relaxed about the impact on members of adopting revised longevity assumptions in their next factor review while those other factors dominate the discussions.
