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The report Apocalyptic demography? – Putting longevity risk in perspective, published by the Chartered Institute of Management Accountants (CIMA) in association with the Pensions Institute at Cass Business School,  provides a checklist to finance directors who may not fully understand how seriously even small changes in mortality assumptions can affect them.

Defined benefit pension schemes promise specific levels of payouts to retired members, putting the investment risk on the shoulders of the companies which run them.

CIMA believes that longevity risk is one of the most challenging risks around today for finance directors. UK life expectancy has nearly doubled over the past 150 years, with a trend of 2 – 2.5 years per decade.

This has consistently exceeded official projections. There is currently no commonly accepted forecasting model when it comes to predicting longevity risk and substantial, unprecedented increases in life expectancy could potentially undermine the financial viability of defined benefit pension schemes across the UK.

Charles Tilley, chief executive at CIMA, says that multinationals and other larger FTSE100 companies are alive to the risks posed by longevity issues, but adds that it is typically smaller to medium organisations that may not realise quite how seriously life expectancy assumptions can impact upon their balance sheets.

The Pensions Regulator estimates that two years of extra life could add up to 5 per cent to a defined benefit pension liability – with liabilities across UK pension schemes adding up to around £900bn, a move of 5 per cent would equal £45bn.

Tilley says that it is therefore imperative that these risks are understood.

CIMA has created its pensions guidance and accompanying checklist to help finance teams manage their pension schemes and put longevity risk into perspective, by encouraging them to question their actuaries more rigorously on the mortality assumptions used in estimating their scheme liabilities.

David Blake, director of the Pensions Institute at Cass Business School, says that longevity risk in pension schemes might not be as significant as interest rate or inflation risk, but warns that having hedged these last two risks using Liability Driven Investment (LDI) strategies such as duration and inflation swaps, the relative importance of longevity risk increases substantially.

“If finance directors do nothing to hedge this risk, they leave themselves exposed to cures for cancer and other medical advances extending the lives of plan members in a way that was not anticipated or reserved for when those members retired,” he adds.

Blake wonders if this is something finance directors really want to have to deal with in the years ahead, particularly when the world is becoming a much more competitive place to do business in.

Apocalyptic demography? – Putting longevity risk in perspective follows on from CIMA's initial report on pensions, The Pensions Liability – Managing the Corporate Risk, which was launched in November 2006 and updated in March 2008.

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Related links 

• CIMA
• CIMA - Pensions