Extreme age has always been a cause for celebration and wonder: witness the blanket media coverage of Henry Allingham’s achievement this year – sadly for just one month – of the distinction of being the world’s oldest man. Mr Allingham, suitably tongue in cheek, attributed his very long life to “cigarettes and whisky and wild, wild women”. In truth, despite the psychological and physical stresses of active service in World War I, he lived a comparatively happy and trouble-free life. His longevity was, like anyone who manages to avoid a life-threatening accident, ultimately determined as much by his genetic make-up as by his lifestyle.
The number of centenarians in the UK is rising annually. Of course, some people will continue to die at a relatively young age, but pension scheme funding calculations assume that this will average out, typically to a lifespan of around 87 years for a man and 89 years for a woman. But what happens when this ‘averaging out’ breaks down?
Someone on a modest pension living longer than expected is not necessarily bad news for pension scheme funding: it is quite likely that there will be someone who dies a little prematurely, which balances this out. However, it is often those who are wealthiest and able to afford the healthiest lifestyles that live longest. If your scheme’s “Mr Allingham” happens to have a very large pension then it will take a lot of premature deaths to compensate.
Take for example Sir Fred Goodwin, whose reduced pension amounts to £342,500 per annum. If he were to live to be a supercentenarian (110+), he would receive around £8m of extra pension payments (in today’s terms).
Longevity risk has many dimensions. Estimating current life expectancy, and how much life expectancy might change in the future, is challenging for all schemes and a risk many trustees and sponsors will be very familiar with. But for many schemes there is also the risk described here of having exposure to life expectancy concentrated in just a few members. What can what can trustees and sponsors do about this ‘idiosyncratic risk’?
The first step to understanding any risk is appreciating what it is, and whether it affects you. Is the funding of your scheme particularly sensitive to how long payments will be made to a small number of members? The next time your actuary carries out funding calculations, it would be worth asking how many members represent the top 25% of the liabilities – you might be surprised at just how few it is!
Secondly, is this a risk you want to take? This is best decided in the context of other risks. Be aware though that the risk of those with the largest liabilities living longer than anticipated in your funding is largest when you use a single life expectancy assumption for men and a single assumption for women. The risk is lower if you use member specific longevity assumptions which allow for those with the largest pensions having markedly longer life expectancy.
For schemes actively managing longevity risk, the discussion is often focussed on buy-in or buy-out solutions using annuities, or using longevity swaps. That said, for some schemes it may also be worth considering a mixed approach – purchasing annuities for those individuals where there is a concentration of idiosyncratic longevity risk and then applying swaps and other products to the residual portfolio of liabilities.
Whatever your approach to risk, monitoring is key as your exposure will change over time. Recalling Sir Fred Goodwin, augmentations of benefits to senior staff or enhanced early retirement terms increase the amount of the scheme’s liability concentrated in a few individuals. Trustee meetings often review the deaths which have occurred over the year, but it is also worth pausing to celebrate those who continue to live to a ‘ripe old age’. But before you pop the champagne, remember that if it is those with the largest liabilities who have survived, then the funding position of the scheme may have worsened.