Title: P A T E R N O S T E R
1Life Death
The end of occupational pension schemes and what
no-one is telling you about life expectancy
30 November 2006
P A T E R N O S T E R
2Drivers of change in the defined benefit pension
buy-out market
Mark Wood, Paternoster
P A T E R N O S T E R
3Drivers of change in the defined benefit pension
buy-out market
Improving longevity
Deficit volatility
4How did we get here?
8000
6000
4000
2006 SSF and PPF introduced
2001 FRS 17 disclosures introduced
2000
1990s Contribution holidays
0
1985
1989
1993
1997
2001
2005
2006
5Life expectancy - has everyone got their numbers
wrong? Richard Willets, Paternoster
P A T E R N O S T E R
6The life expectancy revolution
7.00
140
18
8
years
6.00
Mortality rate for men aged 65-74 in England
Wales
5.00
4.00
3.00
2.00
1.00
0.00
1800
1841
1981
1999
2007
2050
7The pace of change has accelerated dramatically
4.0
3.5
Average annual reduction in mortality rates for
men in England Wales aged 65-74 (smoothed)
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1855
1885
1915
1945
1975
2005
8This is partly due to the emergence of the
cohort effect
In the UK men and women born in the period
1925-45 have experienced more rapid reductions in
mortality rates than generations born either
before, or after, this period
9As the golden generation has aged, the pace of
change has accelerated
4.5
Accelerating improvements
4.0
3.5
Average annual reduction in mortality rates for
men in England Wales born in 1930-34 (smoothed)
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1972
1982
1992
2002
10Deaths from heart disease have reduced
dramatically
1.8
1.6
1.4
Mortality rate from heart disease for men aged
65-74 in England Wales
1.2
1.0
0.8
0.6
0.4
0.2
0.0
1950
1960
1970
1980
1990
2000
11NHS prescriptions related to cardiovascular
disease have increased sharply in recent years
NHS prescriptions (millions per annum), England
Source Department of Health, 2005
12We are now seeing mortality improvements in
cancers not linked to smoking
Change in breast cancer incidence and mortality
over the period 1992-2003 for females in England
Wales
13Projected future improvements for the 1930-34
generation
6.0
5.0
4.0
3.0
2.0
1.0
0.0
1972
1982
1992
2002
2012
2022
14To what extent are pension scheme liabilities
understated?
Scenario 1 Trend reversal
Approximate understatement 75bn
Scenario 2 Continued acceleration
Approximate understatement 175bn
15The future of the new pension fund buy-out
market in the UK Professor David Blake, Cass
Business School
16The development of a new market why?
17Key reason extent of exposure to longevity risk
in UK pension provision finally recognised
(Pensions Commission 2005, Figure 5.17 p181, bn,
end 2003 )
18Effect of increasing competition
19More careful monitoring and management of the
pension liability risk process
- Risk identification
- Price ( wage) inflation risk
- Interest rate risk
- Longevity risk
- Risk evaluation
- Price ( wage) inflation risk
- not rewarded
- Interest rate risk
- not rewarded
- Longevity risk
- high and underestimated
20Longevity fan chart for 65-year old males, using
Cairns-Blake-Dowd model, assuming no parameter
uncertainty
21Longevity fan chart for 65-year old males, using
Cairns-Blake-Dowd model, with parameter
uncertainty
22More careful monitoring and management of the
pension liability risk process
- Risk prioritisation
- Longevity risk
- Interest rate risk
- Price ( wage) inflation risk
- Risk treatment
- Avoid
- Interest rate inflation risks
- Accept, mitigate or exploit?
- Longevity risk
23Improved ALM software
- Does not currently exist
- Major separation between A-side and L-side
- Neither side understands the other
- L-side software is static with drawdown menus for
benefit rules and mortality tables - No capability for stochastic mortality modelling
- A-side software is just asset-allocation optimiser
24We still have a long way to go
Poor matching of asset and liability cash flows
(very common)
140
Asset cashflows
120
100
80
GBP mm
Liability cashflows(Actuarial best estimate)
60
40
20
-
2022
2025
2028
2031
2034
2037
2040
2043
2046
2049
2052
2055
2058
2004
2007
2010
2013
2016
2019
YEAR
Cashflow
profile of assets and liabilities after hedging (
m)
Cash flow profile of assets and liabilities after
hedging (m)
GILTS
Approved AAA
Other AAA
AA
A
80
80
Matched with
A
rated credit overlay
Matched with
A
rated credit overlay
70
70
60
60
50
50
Gilt
-
matched cash flows
Gilt
-
matched cash flows
Very efficient matching of asset and liability
cash flows
40
40
30
30
Liability
cashflows
Liability
cashflows
20
20
(Actuarial
(Actuarial
10
10
-
-
2004
2007
2010
2013
2016
2019
2022
2025
2028
2031
2034
2037
2040
2043
2046
2049
2052
2055
2058
2004
2007
2010
2013
2016
2019
2022
2025
2028
2031
2034
2037
2040
2043
2046
2049
2052
2055
2058
25Strategies UK corporates will follow
26Strategies UK corporates will follow
Traditionalbuyout
Partial/progressivebuyout
Low risk
Risk transfer with profit share
ALM
Asset returnoptimisation
Managingdeficits
High risk
Increasedcontributions
No action
High funding
Low funding
27Future of the UK buy-out market
28A major new solution will be added to existing
solutions
- Existing solutions
- Insurance-based
- Non-insurance-based (pooling pension funds)
- New solution
- Involves investment banks and capital markets
- Creating a traded market in longevity-linked
instruments and derivatives - Will also provide a critical risk management tool
for existing providers - Since longevity risk cannot be effectively hedged
currently
29Its already started with longevity swaps
- Fixed for floating swap
- Fixed leg based on forecast of mortality
- Need good mortality forecasting model
- Currently OTC product
30And the recent success of extreme mortality bonds
- Swiss Re
- December 2003
- April 2005
- AXA
- November 2006
- And the lessons learned from the abortive
EIB/BNP/PartnerRe longevity bond of November
2004 - Especially concerning longevity indices
- Will lead to a traded market in longevity-linked
instruments - That can be used to hedge aggregate longevity
risk
31Conclusions
- Cost differential of buy-out will decrease
- Regulatory and accounting pressures will raise
the reported value of liabilities - Competition will drive down the buy-out price
- but by no more than 20 due to insurance
regulations - So buy-outs become more affordable
- The following can be also be exploited
- Economies of scale in pooling assets
liabilities of mid-sized funds - Regulatory arbitrage
- Introduction of traded market in longevity-linked
instruments to hedge aggregate longevity risk - Both insurance companies and capital markets are
vital to the success of this market - Will result in strong growth in buy-out market in
next few years
32Case studies
Mark Wood, Paternoster
P A T E R N O S T E R
33The DB scheme risk transfer process
Buy-out price and structure agreed
Liabilities assumed by Paternoster
Employer triggers termination
On risk events
Group policy issued
34 P A T E R N O S T E R