FTSE 100 Pension Schemes Further Increase Life Expectancy Assumptions

FTSE 100 company pension schemes have increased longevity assumptions for their pensioners for the sixth consecutive year, according to survey data issued by Mercer. This individual increase alone is estimated by the consultant to add approximately 1% to a typical scheme’s liabilities, but it says that the longer-term cost of continual increases is much higher. 

Mercer’s report showed that at the end of 2011, FTSE 100 companies had increased their UK longevity assumptions by about three months for current pensioners, those aged 65, and by about five months for future retirees, those aged 45. On average, male scheme members aged 65 are now expected to live until age 87.6, while those currently aged 45 who survive until age 65 are expected to live until age 89.5.

“On 2011’s increase alone, a typical £100m defined pension scheme will now have to anticipate finding an additional £1m to meet the cost of their members living longer,” said Warren Singer, principal and UK head of Mercer’s pensions accounting group. “However, over the last six years, assuming no other changes, increasing life expectancy alone would have added around £7m to a £100m scheme using the median life expectancy.”

Compared to Mercer’s original report in 2006, the 2011 figures represent a cumulative increase of about three years in life expectancy assumption. In 2006, Mercer found that, on average, male scheme members aged 65 were expected to live until age 84.5, while those aged 45 who survive until age 65 were expected to live until age 85.9.

“Women are generally expected to have longer life expectancy than males by a few years,” said Singer. “It might be expected that the general trend of increasing life expectancy seen for males over the last six years would be followed by the assumptions adopted for females. However, FTSE 100 company financial statements typically only disclose basic information on life expectancy, and our analysis does not include life expectancy improvements for women.

“The Office for National Statistics [ONS] has recently announced an increase in life expectancy but it wasn’t as fast as previously estimated. We don’t feel that increasing life expectancy has reached a plateau – or even reversing,” he said. “The ONS figures actually still show a higher level of life expectancy improvement than longer term studies and most of the slowing in improvement is at older ages. The impact here is less significant for pension schemes.”

Mercer reports that alongside the increase in life expectancy, the median discount rate has also fallen and is low by recent historical standards. While a technical issue, the implications are profound: the lower the discount rate, the higher the value placed on the pension liabilities. For each 1% fall in discount rate, therefore, the liabilities for a typical scheme will increase by around 20-25%. This is because the compound results of a small change compounded over 20-25 years – the average time when benefits are paid out by pension schemes – can be substantial. The fall in discount rates in 2011 continues the recent trend. Median discount rate has fallen each 31 December year end, from 5.7% a year in 2009 to 4.8% a year in 2011. One typical index, Markit’s iBoxx over 15 year AA corporate index, has fallen from 7.7% in October 2008 to below 4.0% in August 2012.

Singer added: “While the impact of increasing discount rates has been mitigated to some extent by falling inflation expectations, the very significant falls in the discount rate highlight the challenges facing UK companies with defined benefit [DB] pension promises. During 2011 FTSE350 companies made an estimated £25bn of contributions but still watched their deficits grow. The revised version of IAS 19 requires companies to disclose the risks facing the scheme and the actions taken to mitigate those risks. The potential increase in focus on risk from the investor community alongside the reality of the variability in markets over recent years may lead to sponsors reassessing the benefits of investing in risk or growth assets.”

According to Mercer the majority of companies will also see profits reduced in 2012 compared to 2011 as a result of the revisions to IAS 19 (all other things equal) requiring the pension expense to use the discount rate to assess the returns available from the scheme’s assets rather than a long term return assumption.

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