'Apocalypse' warning to company pension funds as life expectancy rises

Defined benefit schemes will risk shortfalls totalling £45bn, claims a new report, if they fail to factor in the effects of medical advances
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The Independent Online

Pension funds for defined benefit company schemes are facing huge shortfalls because members are living far longer than expected, according to a report seen exclusively by The Independent on Sunday.

An investigation by the Chartered Institute of Management Accountants (Cima) and the Pensions Institute at Cass Business School has revealed that the future of defined benefit pension schemes could be hanging in the balance because the life expectancy of members is often underestimated by more than two years. This can leave funds short by as much as £45bn, or 5 per cent of their total value.

The report, called Apocalyptic Demography?, is aimed at finance directors of companies with significant defined benefit pension liabilities. It warns that companies could be in line for unexpected pension scheme bills of millions of pounds, which could undermine the financial viability of schemes across the UK, particularly those of small and medium-sized businesses.

Life expectancy has almost doubled in the past 150 years, increasing by around 2.5 years a decade and consistently exceeding projections that many schemes base their forecasts on. There is no commonly accepted forecasting model for the financial impact of longer-than-average lives on pension schemes, and payouts to increasingly older members could create huge deficits in funding, the authors of the report warn.

There are, the institute believes, a number of organisations with significant defined benefit pension liabilities that may not realise how seriously longevity can affect their balance sheets. This applies particularly to those that have closed their schemes to new employees, and may therefore appear to be a safe bet to potential investors.

"Defined benefit schemes are worth around £900bn at the moment, so they could be missing some £45bn," said Charles Tilley of Cima. "This is a long-term debt: these debts should be paid over time and many larger companies will have longevity risk built into their figures. But some smaller organisations will be unable to meet their contributions, and there are instances of people losing their pensions."

David Blake, director of the Pensions Institute at Cass , urged bosses to review their longevity assessments, saying: "If companies do nothing to hedge this risk, they leave themselves exposed to medical advances extending the lives of plan members in a way that was not anticipated or reserved for when those members retired. Companies will not want to deal with this in the years ahead when the world becomes a much more competitive place to do business."

Cima's report presents a checklist of questions for finance directors, focusing on three key areas where they can gain a better understanding of the mortality assumptions used in their defined benefit schemes.

As the report highlights, current life expectancy owes much to demographic factors – for example, blue-collar workers have a shorter life expectancy than white-collar ones – but there will also be specific issues affecting different schemes: "This means organisations must understand where their scheme sits as far as life expectancy is concerned."

If mortality rates stay the same as in 2004-06, then a 65-year-old man could expect to live another 16.9 years and a 65-year-old woman another 19.7. But there are big regional differences. In Scotland the average age of death is 74.6 for a man and 79.6 for a woman, while in Wales it is 76.6 and 80.9 respectively. In the UK as a whole, the male and female equivalents are 76.9 and 81.3.

The Cass report goes further, showing just how big the regional differences are in mortality. In the North-east, for example, the average male age is 75.8 years old and the woman 80.1 while in the richer South-west and South-east the averages rise to 78.5 and 82.4. respectively. Taking it down to local authority level, men in London's Kensington and Chelsea live on average 8.2 years longer than in Glasgow while the women live an extra 7.7 years.

On top of this finance directors have to build in socioeconomic status into their models – professionals can add 18.3 years to the average 65-year-old while an unskilled manual worker can only expect another 14 years once they get to 65.