Fact : People in the UK are living longer than ever before. Will this trend continue, or are we nearing an ultimate limit on human life? Nearly everyone has an opinion, but who really knows the answer?

The Problem

In short, no-one actually knows with certainty how long pension scheme members will live for!

This uncertainty causes a problem for sponsors and trustees of UK pension plans. The value of scheme liabilities (be it for accounting, funding or any other purpose) continue to increase as assumptions regarding life expectancy are updated to reflect the latest thinking.

In the last 15 years alone, life expectancy assumptions have typically increased by around 10 years, adding around 30% to scheme liabilities.

This trend in increasing longevity means trustees need to worry about whether they are reserving enough money to pay the benefits which have been promised to members, and sponsors suffer from the negative impact both on their accounting balance sheets and profit & loss accounts, and from increased contributions demanded to support the plan.

"Longevity Risk"

The negative impact of this increasing life expectancy is termed "longevity risk". In our 2008 Global Risk Survey, respondents for the UK rated longevity risk as the second-most worrying risk that pension schemes face.

So What Can You Do About It

We advocate a common sense approach to tackling this risk management problem:

Understanding the Risk

Hewitt has a number of tools to help you understand the level of longevity risk your scheme is facing. These range from the "Hewitt Longevity Model" — our individual mortality rating model — to stochastic and stress-testing techniques which we can use on your scheme membership to identify where your risk lies and how severe its impact could be.

We also use our expert knowledge, experience and data analysis skills to advise you how mortality rates might change in the future. Keeping sponsors and trustees of scheme up-to-date with the latest thinking and research helps ensure schemes are as well-prepared as they can be.

With better idea of the risk you are running, you can then either decide whether you want to continue to run that risk (for example, it may be small in comparison to the other risks you are running), or to explore the options that exist to better protect the scheme.

The Hedging Market

Until recently, the main way for a pension scheme to reduce its exposure to longevity risk was to purchase bulk annuities. Despite the 'feeding frenzy' in the bulk annuity market over the past 18 months, for many scheme and sponsors, bulk annuity solutions have tended to come at too high a price in terms of the immediate cash contributions required. In addition, a bulk annuity requires handing over scheme assets to the insurer, which eliminates the potential future upside from the scheme's investment strategy (a key part for most scheme financing plans).

A new market in longevity only protection has now emerged which offers UK schemes the ability to hedge only the longevity risk component of their risk, whilst keeping control of the underlying assets that will be used to pay the benefits. It can be a very cost effective solution for lots of schemes with limited adverse impacts on scheme finances and company balance sheets, and retains the ability to take investment risk where you want to.

Do you find yourself thinking:

"All I've seen is bad news on longevity from my actuary who keeps advocating an ever increasing life expectancy assumption. This adds serious amounts of money to my liabilities each year. I want protection."

"We've put a hedge in for all the financial risks in the scheme — but I'm still worried that longevity risk is still out there and could seriously damage its performance."

I'm happy to run investment risk within the scheme and I understand the financial risks I am taking — but longevity is a mystery to me — why am I running this risk?"

If you do, then perhaps the longevity hedging market might offer something for you.

If you would like to get a better fix on the likely longevity within your scheme, develop a better understanding of likely future trends in longevity from the latest research, or explore options in the market to protect yourself against future longevity improvements, please contact us on the details below and we'd love to talk to you about it.

For more information please email us.