New guidance from The Pensions Regulator, alongside new information collected from insurers and reinsurers, is likely to lead to a fall in life expectancy assumptions due to the impact of the pandemic on future deaths.
In my previous blog I discussed some of the key factors that are affecting how DB pension scheme stakeholders set their mortality assumptions in light of the pandemic. In particular, I noted that the factors could be put into two broad categories:
- Factors that directly affect how long members are likely to live for in the future, such as missed diagnoses and treatments during the pandemic, the health implications of long-covid and better public hygiene.
- Indirect factors such as guidance from The Pensions Regulator and the approach taken by insurers in their bulk annuity pricing.
While the picture relating to the direct factors isn’t any clearer, new information is now available on the indirect factors. This blog explores how the new information will affect how you go about setting your pension scheme mortality assumptions.
New guidance from The Pensions Regulator
At the time of my previous blog, the most recent guidance from The Pensions Regulator (TPR) was that any material changes to scheme funding mortality assumptions due to the impact of the pandemic should be evidence-based and monitored. At the time, it was thought that this may steer trustees to not reduce their funding liabilities as a result of the pandemic’s impact on mortality.
Since then, TPR has published its latest 2022 Annual Funding Statement, in which TPR says that it expects “any reduction in liabilities [as a result of the pandemic] be no more than 2%, unless accompanied by strong supporting evidence”. This is quite a change in TPR’s guidance, in that they are now both providing a green light to pension scheme stakeholders that they can reasonably reduce liabilities in light of the impact of the pandemic, and providing a numerical limit to any reduction.
Following this, TPR have said that this 2% figure should be viewed as a limit and not a target – in other words schemes should not reduce their liabilities by 2% by default and should note that any reduction in liabilities that do not materialise in practice will need to be met by future contributions. However, it seems likely that this change in guidance may well lead to a number of pension schemes starting to reduce their liabilities, particularly in cases where there is significant pressure from cash-strapped employers to reduce contributions.
In light of this new guidance, pension scheme stakeholders should consider whether they believe it is appropriate to now make an allowance for the pandemic through their scheme funding mortality assumptions.
Impact of the pandemic on bulk annuity pricing
Another indirect factor that affects pension scheme funding is bulk annuity pricing. At the time of my previous blog, no concrete information was available from insurers about how they allow for the pandemic in their pricing. The Continuous Mortality Investigation (CMI) has recently published its annual benchmarking survey which, for the first time, asked insurers to provide information on how they expect the pandemic to affect their bulk annuity pricing.
The following chart shows responses to the survey, in terms of liability impact.
While 60% of respondents indicated that they do not expect to make a change to their liabilities due to the pandemic, 40% indicated that they would reduce their liabilities. The average liability impact of the pandemic is to decrease liabilities by 0.3%. This is a fairly small decrease in liabilities in the overall set of factors contributing to bulk annuity pricing, however it’s worth noting:
- for well-hedged schemes, relatively small factors like this that compound together can make a material difference in the timing of a bulk annuity transaction and give better opportunities to access the best pricing
- insurers who reduce their liabilities for the effects of the pandemic may start a “race to the bottom” in reducing liabilities for the pandemic. The more cautious insurers and reinsurers who responded “No impact” to this survey may need to make a reduction to their liabilities in the future for their pricing to remain competitive
This reduction in liabilities comes at a time where bulk annuity pricing is already very favourable for pension schemes, primarily driven by a widening of credit spreads over the past year. This is shown by our DB End Gauge index, which shows that the time to buy-out for UK pension schemes has fallen by around two years since the start of 2022.
In light of this, pension scheme stakeholders should review their solvency position to understand whether they have moved materially closer to buy-out, and if so, to start discussing whether steps should be taken to move the scheme closer to buy-out.
The direction of travel of both of these factors is likely to lead to a fall in pension scheme funding liabilities, and therefore an improvement in funding levels for DB pension schemes. Pension scheme stakeholders should of course be aware though that if these falls do not materialise in practice, this may lead to increased contribution requirements on sponsoring employers.
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