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A survey by actuaries Watson Wyatt of senior finance, treasury and pensions executives from companies with defined benefit pension schemes found that 25 per cent have taken steps to control longevity risk, such as through mortality risk transfer products and mortality sharing benefit design.Some 25 per cent are considering hedging and 8 per cent intend to hedge or buy-out.

"Unanticipated increases in life expectancy can represent a significant unhedged risk for pension schemes," said Steven Dicker, a senior consultant in Watson Wyatt's Corporate Consulting Group. "We are finding that longevity is increasingly being looked at in conjunction with value at risk analyses and other risk management techniques. Benefits are being redesigned to offset longevity increases, and a market is developing to allow schemes to insure or 'swap away' longevity risk."

Scaled back 

Some companies are looking at benefit design changes that explicitly introduce a mortality sharing factor, so benefits are earned according to the standard formula but would be scaled back at retirement if longevity has increased faster than expected.

This is different to simply reducing the benefit formula or making members pay more, which have typically been done in the past to reduce cost or risk generally rather than being specific to mortality.

Other alternatives, according to the survey, are mortality 'swaps' - such as JP Morgan's q-forwards - which are now available as standardised offerings.

"At this stage they are probably only viable for medium to large schemes," said Steven Dicker. "But this may represent the start of a trend similar to that seen recently with interest rate swaps, where pooled fund type approaches make these more sophisticated techniques available to smaller schemes."

Share price 

"However, standardised approaches leave a 'basis risk' between the standard mortality measure and the scheme's actual experience. For transactions between life insurers, and probably for large schemes, swapping on the basis of your scheme's own mortality experience is now a real possibility."

The survey also found that 30 per cent of companies believe that their share price is very sensitive to their pension risk.

"Consistent with other research, we know that companies have their doubts as to how closely analysts look at pensions risk and the extent of its impact on share price," said Steven Dicker. "However, for about a third - possibly those with the largest schemes - this is felt to be a major factor. This perhaps reflects a growing interest in pensions risk from analysts and investors."

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Related links

• Watson Wyatt