Longer lives pose risks for all plan sponsors

The life expectancy of a 60-year-old woman has increased by 2.7 years—from 26.7 to 29.4 years.

DB risks

While longer lives tend to be good news for individuals, they pose a threat for the sponsors of DB plans.

The first risk associated with the release of the updated mortality tables is that sponsors could potentially be using outdated figures, says Gavin Benjamin, a senior retirement consultant with Towers Watson.

But he adds that each sponsor needs to pay attention to the specifics of its own plan, possibly by conducting a mortality experience study for that plan. “Mortality experience can vary considerably based on the membership of the pension plan,” Benjamin says, explaining that socio-economic factors play a role in how long people live.

What complicates things in the long run is that “nobody really knows how mortality rates will change in the future,” he adds.

Another problem resulting from longer lifetimes in Canada, home to the biggest baby boomer group in the world, is the well-documented risk that DB plan sponsors will need to cover more retirees for longer periods of time. This would increase pension liabilities and require bigger pension contributions.

“Although the effect will vary from plan to plan, adoption of the proposed mortality tables and acceptance of the study’s prediction of future mortality improvements could also immediately increase pension accounting liabilities by 5% to 10% for many plans, potentially impacting corporate income statements and balance sheets,” according to a Towers Watson press release issued in response to the new data.

DB solutions

So what can DB plan sponsors do to manage the longevity risk? “When employees retire, the pension plan can offer the option of a lump sum instead of a monthly pension paid by the plan,” says Benjamin.

Sponsors can also pass the longevity risk to an insurance carrier through a scheme where the plan purchases annuities for its retirees, he adds.

DC risks

Although with DC plans risks are borne by the plan members, increased longevity could have a negative impact on employers, too, according to industry experts.

The threat to DC plans starts with lack of awareness. While plan members generally understand investment risks, they “are fairly ignorant of the impact of the longevity risk on their ability to reach their retirement goals,” says Michelle Loder, Towers Watson’s Canadian DC leader.

Unless members become aware of the danger and adjust their annual contribution rates or investment strategies, they will either delay their retirement or outlive their savings, Loder warns.

DC solutions

She says employers should educate their staff about these bleak possibilities because, ultimately, the postponed retirement of their employees would affect them, too.

“Delayed retirement may or may not be desirable depending on the industry you’re in,” Loder says, explaining that, in some professions, productivity could decrease with age.

That is why employers themselves also need to understand the danger of increased lifetimes so they “don’t end up with an ever-growing group of hidden pensioners, which could have a long-term impact on productivity,” Loder says. This could also lead to the escalation of certain benefit costs, she adds.

“Having DC members unable to retire [when they normally would] is going to influence how your workforce evolves,” Loder says. DC sponsors need to examine the longevity prospects of their current workers and make sure that these prospects are aligned with their future workforce goals, she explains.

Once employers are clear about all that, depending on where they want to get to, they can take a number of actions, such as introducing auto-enrollment, disallowing withdrawals, improving default fund options and reducing fees across the board for better investment performance, according to Loder.

Related articles:

• Seniors get “younger”: Report
• Managing longevity risk
• Canada’s aging population presents economic challenges