Longevity risk anxiety overshadows subtler threats
New research commissioned by investment bank State Street has shown that a quarter of pension professionals consider longevity risk to be the biggest threat to pension schemes, but some say it should not take priority.
As people live and draw their pensions for longer, this can create a headache for employers and pension scheme trustees, who have to manage any scheme deficit and the impact it might have on the company. Many therefore now consider longevity the greatest risk a pension scheme has to deal with.
The challenge is to be sensitive to discontinuity between your model and the world. If there is divergence, revisit your model
The State Street research surveyed 400 pension professionals globally; among these, more than a quarter named longevity risk as biggest threat to schemes, followed by investment, liquidity, and operational risks.
While only 22 per cent of respondents said their organisation is effectively managing longevity risk, they expressed high confidence in external and in-house managers’ grasp of the issue.
Data quality underpins all
Alan Pickering, chairman at professional trustee firm Bestrustees, said that despite the concern expressed in the survey, “today there is less denial among employers about calculating the impact of longevity on their pension contributions”, and that “employers and trustees are now better at agreeing on a scheme’s objectives”.
This matters, he said, because a scheme’s end point “should define the order in which risks are tackled” and guide which risks are prioritised.
He called for better awareness of longevity models’ drawbacks, saying: “The challenge is to be sensitive to discontinuity between your model and the world… if there is divergence, revisit your model.”
Pickering noted an omission in the search, calling it very defined benefit-centric. If DB administrators find it hard to manage longevity risk then defined contribution members with greater responsibility for their own pensions might be overwhelmed, he said.
He added that the survey indicated low awareness of an arguably bigger issue. “Data quality underpins everything else,” Pickering said. “It is important that we have up-to-date data, especially as schemes become legacies”.
Investment risk is more urgent
Hugh Nolan, director at actuarial firm Spence & Partners, said that despite longevity risk taking centre stage in State Street’s survey, since DB schemes take on the most risk and create most of their deficit on the investment side, “investment remains vastly more important” in terms of risk management than longevity.
“Conceptually,” he said, employers and trustees understand that people are living longer and driving up pension costs, but find it challenging to act on this knowledge.
Nolan suggested that, to address the risk, schemes can consider taking a “slice-and-dice approach to annuities”, in which you “pick and choose which pensions to insure”, or change scheme rules on member retirement age.
More generally, he advised: “Take small steps; everything you do will take some risk off the table… don’t expect a magic bullet.”
He speculated that as pressure on NHS funding mounts and quality of life decreases, current life-expectency models may change dramatically.
Quantify longevity risk
Neha Bhargava, director of investment consulting at Redington, said that longevity risk “has always been recognised, but schemes’ focus has long been on asset-side risks”, and noted that schemes in their early stages have always prioritised investment risk. Because more schemes are now maturing, longevity risk is receiving more attention.
“Longevity risk is one of the easiest liability-side risks to understand, but it took a long time for solutions for it to come to the market,” Bhargava added.
Bhargava said that despite awareness of longevity risk improving among employers and trustees, “not all understand the implications of longevity hedging”, pushing up collateral costs.
Bhargava pointed out that “there are many idiosyncratic risks not captured by models”, and said that holistic modelling is essential. “Don’t look at any risk in isolation”, she advised.
Most importantly, Bhargava said: “quantify your longevity risk, and look at it in an integrated manner by comparing it to other risks”.
She warned against knee-jerk reactions, saying: “Just because longevity risk is easy to understand [it] doesn’t mean a scheme should take action… hedging is never a no-brainer.”
“Look at the whole scheme” before making a decision, she said.