18 February 2008

The Pensions Regulator’s intention to set a tougher mortality trigger could immediately cost defined benefit pension schemes in the UK as much as £75bn in liabilities, based on figures from Aon Consulting.

The Regulator published draft guidance on its new approach to scrutinising mortality assumptions in defined benefit pension schemes on 18 February. The document states that schemes using any projection less than the long cohort will be investigated. It also says that forecasts which assume that the rate of improvement in mortality tends towards zero, and does not have some form of underpin, will also attract further attention.

Marcus Hurd, senior consultant and actuary at Aon Consulting, confirmed that 99 per cent of schemes that adopt the Regulator's proposals will have to strengthen their assumptions. He explained that the new guidance presumes that the average 65 year old will now live until 90 instead of the previously held 85 years of age.

"This is a knee-jerk reaction to a long-term issue," said Hurd. "Even if the Regulator is right, then companies have a further quarter of a century to solve the problem. The impact is likely to be to add yet another burden to companies and appear to add perceived certainty where there is none. Indeed the actuarial profession's own experts in mortality decline to issue guidance on future projections.

"This is a clear signal that The Pensions Regulator is more concerned with protecting The Pensions Protection Fund than the survival of final salary schemes."

The proposals are in response to growing evidence that people are living longer, leaving existing longevity predictions looking increasingly out-dated.

Chief executive of The Pensions Regulator, Tony Hobman, explained: "Over the past couple of years there have been significant developments in our knowledge of trends in mortality. It is the Regulator's view that some projections that have been in common use can no longer be considered reasonable assumptions. We wish to bring these developments to the attention of trustees and outline how they should go about deciding on funding assumptions for defined benefit schemes."

Watson Wyatt welcomed the sentiment to provide more guidance for trustees and employers, but expressed concern at the likelihood that it will become a standard for scheme funding. James Wintle, senior consultant for the firm, highlighted the unpredictability of mortality risks: "If trustees and scheme sponsors think that by complying with the new trigger points they protect themselves against these risks then they are going to be in for a big surprise."

For example, mortality projections can be affected by a variety of factors. According to Dr David Blake, professor of pension economics at Cass Business School and director of the Pensions Institute, the future remains unknown. He told delegates at a conference on managing demographic risk in London on 13 February at Charing Cross Hotel that longevity hypotheses fall into two camps. There are the pessimists, who believe that life expectancy might level off or decline due to the impact of environmental factors such as obesity and global warming, and there are the optimists, who suggest that there is no natural limit to human life. Strengthening assumptions could prove necessary, but likewise, could be unwarranted, leading to surpluses that are difficult for the scheme sponsor to recoup.

NAPF chief executive, Joanne Segars, recommended that the Regulator and Government "tread carefully" if the new period of stability in occupational pension provision was to be more than just a temporary phase. "The pressure valve cannot continue to be tightened so any increase in costs must be offset by lighter regulation to help keep existing defined benefit schemes open,” she said.

"Examples of lighter regulation include making it easier for surpluses to be returned if people do not live as long as expected or giving employers leeway to increase newly promised pensions by less than inflation if life expectancy rises much faster than expected."

Concern has also been expressed that negotiations surrounding valuations between employers and trustees might be disrupted as a result of the Regulator's actions, which could leave many trustees "potentially unable to complete valuation," said Danny Vassiliades from Punter Southall. He claimed that trustees will be left wondering whether they should wait and see if the Regulator's plans are adopted before finalising their funding agreement.

Alexander Forbes Financial Services' regional director, Alan Carey, is adamant that UK pension schemes should be shepherded into a one-size-fits-all scenario. He said that the decision makers best placed to judge suitable projections for their own scheme membership were the trustees themselves – with help from their professional advisers: "Whilst prudence is an over-riding principal in the proposed mortality triggers, no attempt has been made in the regulations to give an exact definition, thus it will mean different things to different people at different times.

"Herding all schemes into the use of a common table and projection basis will erode the scope of trustees' discretion and remove the need for advisers' workload and pointless duplication of effort by the Regulator, which may result in increased TPR levy costs for all DB pension schemes."

Wintle from Watson Wyatt added: "It will be important for the trigger to be kept under review; the Regulator has to demonstrate that it can update guidance as rapidly as schemes have reacted to new research on mortality in the past or it will risk stifling the evolution of good practice."

- Pensions Age March 2008