Increases in life expectancy have been consistently underestimated over the past few decades, creating funding difficulties for pension plan sponsors, according to a recent report by Swiss Re. The reinsurer suggests that plan sponsors should adopt forward-looking models instead of relying on traditional methods that don’t take emerging trends into account.
“The failure to consider future drivers of mortality in historical predictions contributed to employer pension funds under-reserving for longevity risk, and other bodies, including governments, not budgeting effectively for funding an aging population,” says Daniel Ryan, head of life and health research and development at Swiss Re.
Longevity risk is the financial risk that people will live longer than expected, resulting in additional, unexpected liabilities. And managing longevity risk requires developing robust, predictive approaches, says the report. These approaches would use forward-looking scenarios based on social factors, medical treatments and advances, and preventative approaches that influence disease and lifespan.
In order to create such scenarios, the report points to improved access to information and sharing of research between governments and other organizations.
“Public databases have become more widely accessible to commercial organi[z]ations in recent years,” says the report. “With such valuable resources at their disposal, organi[z]ations that carry longevity risk should take advantage of the opportunity to improve their understanding.”
However, Ryan points out that while increased information provides a better prediction model, it will likely provide unexpected results, given past prediction methods.
“It may be that the improvements…are a bit higher than those currently assumed, depending on the pension [plan],” he says. “Therefore, [employers] may be thinking, ‘This uncertainty in this new situation is more than I really want to take, and it’s not to the benefit of me as a corporate entity.’ And the pension trustees may think, ‘This is not really to the benefit of our individual members, so is there an organization that’s prepared to take some of this longevity risk off our books?’”
“Employers and pension plan managers need to assess their potential longevity exposure and decide whether it is best to retain it or pass some, or all, of it on to a third party that may be better placed to take on, and aggregate, the risk,” says the report. “Such a third party should have made the appropriate investment—in terms of both funding and resource[s]—into an effective mortality model and hold the financial capacity to manage such a long-dated commitment.”
Ryan also points out that such solutions don’t have to apply to the entire pension plan. As an example, he suggests passing the longevity risk in respect of individuals currently receiving pensions on to third parties but holding on to the deferred annuities for those who have yet to retire.
A full copy of the report is available here.