Should pension schemes insure longevity in a post-Covid world?
1st February, 2022
After a relatively slow start in the early months of 2021, settlement activity picked up considerably later in the year, and a large number of transactions were completed for schemes of all sizes well into December. Although insurer results will not be published for some weeks yet, it is clear that a challenging financial environment did not stop schemes from pursuing their de-risking goals; and it is widely expected that 2022 will be a record-breaking year, with up to £60 billion of business being written over the year.
A question that sometimes comes up when discussing settlement matters is: does the impact of the pandemic mean this may not be the right time to insure a scheme’s longevity risk, either via a bulk annuity or a longevity swap; and should settlement exercises perhaps be paused while further evidence emerges? I think this question can be looked at from different angles, but my answer would be a clear ‘no’. I am certainly looking forward to helping my schemes with an endgame objective of insurance meet their aims in 2022!
Look beyond the ‘worst case’
The impact of the pandemic on life expectancy is, of course, a relevant consideration. However, while some of the newspaper headlines on this subject have been very alarming, the bleak picture of declining life expectancies was usually looking at ‘worst case’ scenarios, modelled on the basis that the number of deaths occurring during the pandemic would continue in the future. This is a very pessimistic assumption. While it is undeniable that the pandemic has resulted in negative pressures on life expectancy, for example, in connection with the uncertain prevalence and impact on future mortality of long Covid, there are also pressures in the opposite direction, including the emergence of new types of vaccines. For members of defined benefit (DB) pension schemes, who tend to be better off than the general population (for the same cohort), the overall impact is further diluted as vulnerable pensioners are perhaps more likely to be cautious in their behaviours than was previously the case. An argument can also be made that deaths which have occurred in vulnerable groups, such as within care homes, may lead to better life expectancy in the future for the survivor group.
The second consideration is around the cost of insuring longevity risk. After all, if expectations of future mortality are changing, insuring longevity risk is still a sensible decision in financial terms if the cost of such insurance is seen as “fair”. This assessment is, of course, very circumstance dependent, which is the reason why extensive modelling is undertaken in advance of any settlement activity, with the aim of agreeing financial metrics suitable for each scheme at that point. While there does not seem to have been any significant adjustment to insurers’ and reinsurers’ longevity assumptions, I do not believe that anybody is suggesting that these are now inappropriate. If anything, the emergence of more uncertainty around future mortality rates (or perhaps just an increase in awareness around this uncertainty) should mean that curtailing risk is now seen as even more attractive.
Achieving best outcomes for members and sponsors
Arguably though, while the above considerations are relevant, they are not the key ones for DB pension schemes. These schemes are mostly legacy arrangements, very onerous both in terms of running costs and the governance burden they impose on scheme sponsors. These issues are only going to be exacerbated in the future as new requirements around governance, funding and investment come into force over the next few years. Improving funding levels, mostly the result of increasing sponsor contributions over the past decade, mean that bulk annuity transactions can be completed for many schemes with limited additional support needed from the sponsor, or none. It is this bigger picture view that drives most settlement activity, rather than an in-depth analysis of the component parts of the premium. I believe this is absolutely the correct approach and likely to result in the best outcomes for members and sponsors.
Our strategy for pension schemes with a buyout endgame remains unchanged:
- confirm the scheme benefits, and amend if required to make the scheme insurable;
- cleanse scheme data as much as possible, including collecting spouse data;
- set up the appropriate governance structure to support your plans;
- set out detailed plans with measurable intermediate objectives; and
- pursue these with the support of your advisers.