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.”

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.”