FTSE 100 Companies Face £26bn 'Longevity Gap'
05 October 2009
Hewitt Associates, a global human resources consulting and outsourcing company, has said that FTSE 100 companies are in danger of sleepwalking into reporting an unnecessary £26bn in pension liabilities in their accounts.
UK 'longevity gap'
The additional amount relates to the differing assumptions used by companies and trustees in predicting the life expectancy of the members of UK's largest defined benefit pension funds. On average, FTSE 100 companies currently assume a life expectancy for a 60-year-old male of around 86 years in their annual accounts. By contrast, trustees of the same schemes are predicting life expectancy of around 88 years.
Hewitt is warning UK companies against simply adopting trustees' longevity assumptions as they have done in the past, as scheme funding and accounting rules require companies and trustees to take different approaches to predicting longevity. While companies are required to report a 'best estimate' for their financial accounts, trustees are required to use a 'prudent' approach for the purposes of scheme funding valuations.
The differences between the two sets of assumptions highlights the challenges that schemes and sponsors face when predicting life expectancy, and the impact this can have on a company's financial health.
Martin Bird, head of Longevity Solutions at Hewitt Associates, said: "The life expectancy of scheme members is one of the most critical risks currently facing companies with defined benefit pension schemes, particularly as people are living longer. Not only does it impact scheme valuations significantly and, therefore, the amount the sponsor is required to contribute to the scheme, but it also has a direct impact on the company's accounts.
In the current environment it is vital that companies do not sleepwalk into a potentially costly and inappropriate set of assumptions by simply following the trustees, as they have done in the past. Companies need to take an independent look at their longevity assumptions to avoid adding in layers of inadvertent costs."
Calculations by Hewitt show that for every year that member life expectancy increases, scheme liabilities rise by between three and four percent. Therefore, if FTSE 100 companies just adopt assumptions in line with trustees, as they have done historically, it would add a further £26bn to their collective liabilities.
Record pension deficits
The news comes at a time when the FTSE 100 is facing its largest ever collective deficit of £75bn and many of the UK's largest companies are trying to manage and reduce their pension scheme risk.
Matt Wilmington global risk management specialist at Hewitt Associates said: "Longevity is climbing up the risk agenda as companies and trustees have started to realise the potentially massive implications of a longer life in retirement. It now rates in the top three pension risk concerns of trustees alongside equity volatility and interest rate risk. As companies start to realise the implications of increased life expectancy on their financial health, they are working with trustees to identify means of managing – or entirely removing – this risk.”
Earlier this year Babcock International completed the first ever longevity swap when it secured a deal for fixed payments for a finite term to a third party, in exchange for the actual value of pensions due to members - regardless of how long the members and their dependents live. Hewitt believes the longevity swap market will see a minimum of six deals over the next year, with a total value of over £5bn.
While historic methods of assessing longevity risk have relied on very basic demographic data, Hewitt believes that approaches are becoming more sophisticated, with the UK's leading pension schemes implementing a much more bespoke approach to predicting life expectancy.
Bird concluded: "In the past, many companies and schemes typically relied on a small number of factors, such as age and sex, to predict longevity and companies simply adopted the same assumptions as the trustees for their annual accounts. Techniques for setting assumptions have now become much more sophisticated, relying on a myriad of health, wealth and lifestyle data which has enabled a greater understanding of a scheme's underlying liabilities."
