On Monday 18th February 2008 The Pension Regulator published a draft statement modifying its approach to looking at mortality assumptions within defined benefit pension schemes. The approach has been developed in light of emerging evidence coming primarily over the last year from recovery plans submitted to the Regulator.
Schemes who use assumptions for future annual improvements in life expectancy that appear weaker than the Long Cohort assumption can expect to come under scrutiny with the Regulator initiating a dialogue with trustees where it feels this is appropriate. The draft also suggests that schemes assuming that life expectancy will not continue to increase indefinitely may also draw further attention!!
The Regulators move is totally reflective of market experience but will undoubtedly result in increased liabilities for many schemes at a time when they are already suffering at the hands of a volatile investment market. So what sort of liability increase might we witness?
Our research would suggest that using the strengthened Long Cohort assumptions with annual improvements in mortality rates of at least 1% compared to using the Medium Cohort assumptions would see a 9% increase in liabilities for a 65 year old male retiring in 2028.
It’s also very difficult to gauge the impact of these mortality improvements consistently between companies as the mortality assumptions used need not currently be disclosed under FRS17 although this will be addressed for all accounting dates after April 2008 as FRS17 disclosures come more in line with IAS19.
Experience would suggest that final salary schemes tend only to review their mortality assumptions when completing their triennial valuations rather than on a more frequent basis. This could result in something of a ‘double whammy’ for businesses. Some schemes may not have even fully incorporated evidence of historic improvements in life expectancy already gathered nor made any significant allowance for improvements in the future. They will now need to review both their assumptions about the current rates of mortality being experienced and their assumptions about improvements in life expectancy in future. Many scheme sponsors are likely to be shocked by the potential impact to their funding position and the likely increased level of contributions required to plug an even larger scheme deficit.
We can only see this news putting further pressure on schemes and forcing further closures, especially when viewed in conjunction with the increased cost of the risk based PPF levy and scheme specific funding.
Scheme sponsors and trustees need to be aware of the impact of these improvements in mortality on their scheme as soon as possible to allow them to take informed decisions. Companies will need to take a much more realistic approach to funding the pension promises already made as well as considering how practical it is for them to be able to continue to accrue additional liabilities under such arrangements.