Insuring too much for living too long

over insured.jpg

I went to an interesting debate this morning about the DB deficit crisis (what crisis?).

A number of interesting things emerged, such as a statement that a pension scheme cannot get a real return on its investments. I looked at the trustees beside me who told me he was getting a real return from the dividends from his share save. As he drove trucks for Wincanton Transport , I thought this observation had considerable weight. I too invest in shares which – whether they are up or down by valuation – pay consistent dividends which are well above the rate of inflation.

As much of the previous 30 minutes had focussed on longevity swaps, buy-outs, buy ins , LDI and (a new one on me) – insurance securitisations, I was prompted to ask a question “why don’t pension funds invest more in equities?”

It would seem that it was alright for me to invest in equities as I was a DC investor but not alright for Trustees to invest in equities as they had responsibilities to their sponsor not to put strain on the balance sheet (PA2014). This was confusing to me and my truck-driving friend as there had been talk of the Regulator wanting to restrict the capacity of companies to pay dividends if a Scheme was in deficit. He whispered to me that this would rather mess up my DC investment strategy and his bit on the side from his company shares.

As the FT recently reported , it would be possible to wipe out pension scheme deficits by our largest companies not paying any dividends for a year. We’d just have a load of bust DC pensions drawdowns and companies trying to raise yet more debt as equity investors chose other countries for equity returns. The truck-driving Trustee and I were as one, equities seemed a lot more important to us than to pension schemes!

Investing in bonds to match liabilities is regarded as a hedge (an insurance). It is of course an imperfect hedge as bonds don’t last as long as pension liabilities and certainly don’t insure the happy circumstance of people living too long.

We also learned this morning that we are paying a very high insurance premium in case we live longer than expected. Hyman Robertson reckon that occupational pension schemes are currently reserving £25bn too much against the longevity risk they are collectively taking.

This is an understatement, according to my friends who sell longevity swaps (who have built in margins of between 5 and 8% above the current actuarial estimates used by pension schemes. Based on their being £1tr of liabilities to be insured, then a 5% margin would suggest £50bn “prudence” – and 8% margin an £80bn buffer.

Undoubtedly, those who sell longevity insurance will want to retain the buffer in schemes, it makes buy-outs so much more doable!

Why the under estimate of mortality? Well the last five years have shown much higher mortality than has been expected – some suggest that mortality has plateau-d (though some have been saying this for centuries). It would seem that we may have over-cooked the “first man to live to 200 is already on the planet” story.

We are – most probably over insured against living too long.

I think it as likely that the actuarial prudence with which pension schemes are managed has added on this extra £25-80 bn as a kind of tip. The trouble is that most sponsors are struggling with the bill without a gratuity!

I like Douglas Anderson of Hymans Robertson so I won’t spoil this story any more than I tweeted this morning. The FT are going to run the article soon and Jo Cumbo will report the facts more professionally (and succinctly) than I.

But I’ll leave you with a thought which I very much doubt will be in the forthcoming FT account. Funded pension schemes invest money to meet liabilities. Annuities are an insurance against liabilities , they do not invest, they match out liabilities. Insurance companies will exaggerate liabilities to increase premiums but will seek to minimise pay-outs in the event of claim.

It occurs to me that the less a pension scheme, or a DC investor , or a truck-driving man, have to do with such insurance practices , the better their retirement! Perhaps the pension schemes who are courting buy-out, buy-in , longevity insurance and LDI should think along our lines!





About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in pensions and tagged , , , , , , , , , , . Bookmark the permalink.

Leave a Reply