A spike in the UK mortality rate could raise concerns for defined benefit pension schemes that have implemented longevity hedging, as it could trigger collateral calls on their longevity swaps.
However, consultants are adopting a wait-and-see stance, as it is too early to tell what the virus’s impact on scheme longevity risk will be.
According to a Financial Times analysis of data from the Office for National Statistics published on Wednesday, the coronavirus pandemic has caused as many as 41,000 deaths in the UK.
Consider how longevity stress might interact with other collateral requirements in the scheme, such as liability-driven investment hedges, currency hedges and synthetic equity positions
Alex Lindenberg, Redington
The estimate is more than double the official figure of 17,337 released by ministers the previous day, and higher than the provisional number of deaths registered in England and Wales provided by the ONS – which stood at 18,516 on April 10.
The picture provided by the Continuous Mortality Investigation is also bleak, with the cumulative mortality improvement for 2020 falling to minus 2.7 per cent from 0.1 per cent in March.
Schemes warned to have ‘prudent levels of liquidity’
The overall impact of declining pension scheme member longevity will push down DB member liabilities. However, schemes that have entered into longevity swaps may see a short-term rise in mortality trigger collateral calls, said Alex Lindenberg, a director at Redington.
Swap contracts typically use the recorded longevity of pension members to determine the cash flow to or from the counterparty on an agreed timeframe. This varies from scheme to scheme, ranging from between three and 12 months.
Trustees with existing longevity swaps should therefore “ensure that their schemes have prudent reserves of liquidity” in place for longevity collateral, as well as considering “how longevity stress might interact with other collateral requirements in the scheme, such as liability-driven investment hedges, currency hedges and synthetic equity positions,” Mr Lindenberg added.
Longevity swaps have been in relatively high demand over the past decade. Since the first contract was agreed between the Babcock International Pension Scheme and investment bank Credit Suisse in 2009, the market has grown considerably to roughly £90bn, according to a recent estimate by Hymans Robertson.
A Willis Towers Watson report on derisking published earlier this year stated the longevity swap market was “incredibly busy in 2019”, in addition to being a record year for the bulk annuity market, with £41bn worth of transactions completed.
Greater challenge for longevity modelling
The jury is still out, however, as to whether rising mortality rates will have a material effect on the pension schemes entering these agreements.
Adam Davis, managing director at K3 Advisory, said he would be “very surprised” if there were vast numbers of margin calls on longevity swaps. But he said it is not unheard of for schemes – especially less well-funded ones – to find themselves in these “awkward positions”, where they need to liquidate assets to honour margin calls on hedging contracts.
Mr Davis also cast doubts over the degree to which DB members are likely to be among those worst affected by the virus: “The average age in a pensioner portfolio is [often] 65 to 70 years old and not over 80 [...] DB scheme members are often affluent people able to deal with health risks.”
During an Aon webinar on pension scheme derisking transactions, the consultancy kept its median longevity outlook unchanged from that established before the outbreak. At the time of recording, on April 3, the ONS had recorded a provisional number of 16,387 deaths in England and Wales.
Martin Bird, head of risk settlement at Aon, admitted that since the webinar it has become “more apparent that this is going to be a heavy year”, but as for the question of collateral calls, it is “just too early to tell”.
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The unknown wider implications on future mortality rates make any longevity modelling difficult at this stage. On the one hand, the disease may create a more resilient population as it is the most vulnerable whose lives have been lost. On the other hand, with a large proportion impacted, it could be that the post-Covid-19 population is left more frail.
As for new schemes looking to enter into a longevity swap, this will probably be a moment to pause and reflect, consultants predicted. But as the uncertainty is set to create more – not less – risk in the system, Mr Bird expected the derisking market to remain “buoyant”, even if bulk annuities continue to be more attractive than swaps.
Sam Mullock, a partner at First Actuarial, noted that at the moment the investment hit to schemes is of comparatively greater concern. However, the real challenge will come further down the line when it becomes clear whether this is a “one-off blip or if there are types of Covid viruses every year”, he added.
