The first is the Accounting Standards Board’s discussion paper on the financial reporting of pensions. Suggested changes, to reflect more closely what a scheme’s liabilities were at the balance sheet date, will probably mean increases to disclosed liabilities for all schemes.
However, it is The Pensions Regulator’s consultation on longevity that has caught the pension industry’s attention. It claims that trustees of defined-benefit schemes have been underestimating how long people will live and failing to use up-to-date data allowing for longevity improvements.
It estimates that only 2 per cent of schemes are using the latest figures, which predict that a 65-year-old man will live to 90 – an increase in life expectancy of two years. Where schemes have not updated the assumptions, changing the longevity basis will come at a cost. The regulator puts the price at an increase in liabilities of up to 8 per cent.
The regulator is consulting on how to tackle this and is proposing that trustees move to a long cohort basis and adopt a minimum year-on-year improvement factor. If they do not, this will act as a trigger for the regulator to take a closer look at scheme-specific funding.
Of course, trustees should be aware of the latest data and improvements but they should also be cautious of kneejerk reactions. Trustees have to decide the longevity basis for their own scheme and be able to justify it to the regulator if need be but not necessarily adopt the basis put forward by it.
Ideally, trustees should use their own experience as a guide but that is difficult for small and medium-sized companies, which may not have enough data to identify patterns. Trustees can instead seek help from those who offer sector and geographical data to make sure they use the right longevity basis, rather than a non-specific average.
We have to face up to the fact that most trustees of private defined-benefit schemes are now putting into place and managing their exit plans. There will only be a few trustees with open schemes. Tightening up liability calculations and longevity bases only serves to emphasise the risk management issues faced by employers. Trustees and employers have to work together to incorporate these issues into the design and implementation of exit plans.
The good news is that it is a buyers’ market. Over the last few years, the buyout market for bulk annuities has exploded from two players to around 20, offering trustees and employers innovative ways of managing their risk.
At one end of the scale, new and established life insurance companies have entered the market offering tranched buyout exit plans and ways of managing longevity and investment risk. At the other end, we are beginning to see new solutions evolve, where companies buy the pension scheme, breaking the employer’s covenant.
Understandably, the regulator is keeping an eye on these developments as its most pressing concern is security of member benefits.
All this adds up to a very competitive market. Some of the prices on offer look almost too good to be true but providers argue that they are based on the specifics of scheme membership, rather than relying on averages.
Like any market where supply exceeds demand, with low prices, the bubble has got to burst at some point. I would be surprised if the choice of buyout providers was as extensive in 12 months time. Instead, we are facing a Darwinian battle and only the fittest will survive.
In the meantime, employers and trustees are in the driving seat. They should re-examine risk management plans, taking account of the new developments and low prices. Advisers can add value here, building on their knowledge of the insurance market and extending this into longevity risk products. Now is the time for employers and trustees to take action.
Rachel Vahey is head of pension development at Aegon