Page last updated at 10:15 GMT, Friday, 15 February 2008

Pension costs set to be increased

Comedy character Victor Meldrew
Living longer poses a big problem for pension scheme finances

Company final-salary pension schemes may soon have to use much more realistic assumptions about how long their members are likely to live.

On Monday, the Pensions Regulator will publish a consultation document outlining plans to make schemes increase their longevity estimates.

Such an increase would raise the cost of funding many schemes, potentially pushing some into deficit.

Each extra year adds between 3% to 4% to the cost of providing a pension.

The plan was first outlined at a pensions industry conference earlier this week.

In the Financial Times, Charlie Massey, a senior official at the Pensions Regulator, said that, while longevity is impossible to predict, "we do believe that schemes are underestimating how longevity will continue to improve in the future".

Weak assumptions

The regulator has been worried for some time about schemes underestimating how long their members will live.

The scale of the problem has become clear because the regulator scrutinises the estimates of life expectancy being used when schemes which are in deficit file a recovery plan.

It believes that the mortality assumptions being used are often weak.

Now, if it sees out of date assumptions about future improvements in longevity, it proposes to use this as a trigger for an even closer look at the scheme's recovery plan.

This threat, it hopes, will prod scheme actuaries, trustees and employers into using more prudent estimates.

The knock-on effect, however, is that this could force a much higher level of contributions, and in some cases might provoke employers into closing their schemes on the grounds that the costs have become uncontrollably high.

Costs

Pension scheme actuaries typically use a variety of data to calculate just how long their scheme members will live.

It is still quite possible that either significant surpluses will emerge or that further strengthening of the assumption will turn out to be necessary
James Wintle, Watson Wyatt

In big schemes with many members, the actuary can look at how long the retired staff are actually living, though crucially they still have to estimate how much that might improve in the future.

For smaller schemes, actuaries may base their assumptions on mortality data either from the Office for National Statistics (ONS), or from the Continuous Mortality Investigation (CMI).

The CMI is a permanent research programme sponsored by the Institute of Actuaries, which monitors the life expectancy of members of pension schemes run by life insurance companies.

Legally the choice of mortality assumptions to be used is down to trustees, on actuarial advice, though there is usually a process of negotiation with the employer who will usually not want to see their costs increase suddenly.

Major shift

Earlier this month, the big actuarial firm Watson Wyatt published an analysis suggesting that nearly half of the pension schemes of FTSE 100 companies had changed their mortality assumptions in the past year.

On average they were expecting their members to live for an extra 16 months.

This change suggests that the majority of firms are now moving in the direction the regulator would like.

But Watson Wyatt warned that there was still a wide range of opinions among the medical profession, demographers and other specialists about the outlook for future mortality rates.

"The danger in blindly following the regulator's trigger points is that trustees and sponsors could be misled into believing that by funding at this level all mortality risks are covered," said James Wintle of Watson Wyatt.

"In reality it is still quite possible that either significant surpluses will emerge or that further strengthening of the assumption will turn out to be necessary at future valuations," he added.




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