David Worsfold
Legal & General’s half year results took people by surprise when the insurer released £126m from reserves put aside to cover future pension liabilities. Even more surprising for many was the reason – the sustained slowing down of the rate of increase in life expectancy since 2010.
The conventional wisdom for generations has been that life expectancy will continue to increase much at the same rate as it did for most of the 20th century. Figures from the Continuous Mortality Investigation (CMI) have confirmed that this expectation has been dashed, mainly because of the huge, previously unforeseen, growth in dementia cases. In round numbers, this has meant that the rate of growth in longevity has halved in the second decade of the 21st century with a one year increase for women now taking 10 years and for men 6 years.
This is going to have huge implications for the calculation of the future liabilities of pensions funds, the returns they will need to produce and the deficits they are likely to run up. L&G’s £126m release is thought by most analysts to be cautious with up to double that to come from them over the next two years if the current trends are sustained.
The changes are potentially significant according to the CMI data with years being trimmed off the previous projections of life expectancy used by pension scheme managers (see tables). 
This will have a major impact on the reserving policies of the major insurers – as we have seen with L&G – and on the projected deficits of the large defined-benefit schemes that have become such a burden on firms in the last few decades. The typical scheme could see a reduction of liabilities up to 3%.
Asset managers might think this should take some of the pressure off them and, for many, it might do. But there is a potential twist which could actually see some being asked to squeeze a little more out of pension fund assets.
Recently released analysis by PwC of publicly available data on UK defined benefit pension funds reveals how this is something of a double-edged sword. Projected deficits could come down to almost manageable levels. However, in doing so strategies on how to fund them could change.
If the current trend continues, PwC says £310bn could be wiped off the aggregate £530bn UK pension deficit, leaving a £220bn gap.
The key figure for chief investment officers and asset managers to focus on is that £220bn. According to PwC, pension fund assets would need to grow by an extra 1% a year more than currently assumed in deficit calculations, for the next 20 years, to cover that remaining £220bn deficit without needing company cash contributions.
Raj Mody, PwC’s global head of pensions, said: “Any given pension fund will have to think about how the national data affects their situation specifically. That will depend on the composition of their membership relative to the UK population generally. However, £310bn could be shaved off pension deficits if the latest life expectancy trends are assumed to continue and allowances for previous long-term improvements are removed.”
“That then puts a fuller funding situation within reach for many pension funds, without relying on excessive cash contributions to repair deficits in the short term. For example, if assets grew by an extra 1% a year than otherwise assumed when working out deficits in the first place, that on average would cover pension liabilities without the need for company cash contributions. Clearly the right strategy for each pension fund will depend on their specific circumstances.”
It is not hard to imagine so company boards reviewing that and breathing a huge sigh of relief. Many will have been looking at having to fund huge – and growing – deficits. The saga of Tata Steel is just the latest example of otherwise viable businesses or major deals that are thrown off course by their pension deficits. Hold out to those firms the possibility that those deficits could be covered by a 1% improvement in returns on assets and you can see how asset managers will find themselves under additional pressure to improve returns.
The change in projected life expectancy is also having an impact on the buy-in and buy-out market, according to Charlie Finch, a partner at LCP.
“This reduction benefits pension plan funding and will make full buy-out transactions more affordable.
“Looking ahead, 2017 is well on track to exceed £10bn of buy-ins and buy-outs for the fourth year running and has the potential to exceed the record £13.2bn set in 2014. There remains significant capacity and competition – even if a large back book comes to market – providing attractive opportunities for pension plans to transfer longevity risk through a buy-in or buy-out”.
Of course, all it takes is a major medical breakthrough with Alzheimer's disease and we will be putting all the deficit projections back up to the previously frightening levels.