The £11.4bn scheme has followed other large schemes – including John Lewis and BAE Systems – in using longevity adjustment factors to manage risk
Schemes that use longevity adjustment factors are able to reduce the rate of members’ pensions at retirement to take account of their increased life expectancy, thereby sharing the risk with members.
Longevity adjustment factors in practice
British Steel: The longevity adjustment factor is applied to benefits coming into payment for service on and after April 1 2012. Pensions coming into payment before April 1 2015 are unaffected.
BAE Systems: The longevity adjustment factor is applied to benefits earned in the scheme after April 5 2006. Different factors apply to benefits on normal retirement, ill-health retirement and benefits payable following death before retirement.
John Lewis: A single longevity adjustment factor is calculated each year, taking into account life expectancy, pension increases and the interest the pension fund earns on its investment.
This helps schemes reduce the impact of dramatic increases in life expectancy.
British Steel has applied the tool to benefits coming into payment for service on and after April 1 2012. But pensions coming into payment before April 1 2015 will be unaffected.
Speaking at a conference in March, Allan Johnston, trustee chairman of the British Steel Pension Scheme, said rising longevity was becoming an increasing problem due to the scheme’s 100,000 pensioner and 40,000 deferred members.
These vastly outnumber its 18,000 active members.
“A longevity adjustment factor will be introduced to provide greater protection in case future increases in life expectancy are greater than assumed,” he said.
But while the tool is a handy way for schemes to share the risk of rising longevity with members, it is not without risks of its own.
Risks involved
The longevity adjustment factor is calculated using assumptions, and the main risk for schemes implementing these is if those assumptions are wrong.
One of the biggest issues with this type of arrangement is explaining it to members
Jane Kola, Wragge & Co
According to the Department for Work and Pensions, each extra year of life expectancy increases the liabilities of defined benefit pension funds by about 0.5 per cent.
“Any employer still running an open DB scheme is desperate to cap costs,” said Pauline Armitage, a self-employed actuary.
But she added: “It won’t cut costs, but it may cap the increase in costs.”
Jane Kola, partner at Wragge & Co, added: “One of the biggest issues with this type of arrangement is explaining it to members and managing member expectations when it is applied.”
Limited take-up
Although schemes such as John Lewis and BAE Systems have applied longevity adjustment factors, there has been limited wider take-up.
The main reason we have not seen a rush towards this type of structure is that they only work for future accrual
Andrew Gaches, Club Vita
Andrew Gaches, longevity consultant at Club Vita, said: “The main reason we have not seen a rush towards this type of structure is that they only work for future accrual."
In the case of the British Steel, the longevity adjustment factor applies to service from this April.
While it serves to reduce British Steel’s future longevity risk, other derisking strategies are needed to deal with the longevity risk for benefits already built up.
Longevity adjustment factors are therefore more appealing to schemes which have significant expected future accrual. But the closure of DB schemes over recent years has meant there are relatively few such schemes.
Employers are more likely to close schemes to future accrual than adjust the way benefits are calculated for future service. Schemes also tend to look at how to manage the risk of longevity of accrued benefits by considering securing benefits with insurers which then carry the longevity risk. In a few cases schemes have used longevity swaps.
