In recent years firms have stuffed a lot more money into their final-salary pension schemes. With a fair wind from more favorable markets, that helped to plug the big deficits that had emerged.
Now it turns out that some of the improvement may be illusory. The Pensions Regulator said this week in a consultation paper that it will insist on tougher assumptions about longevity trends when the trustees responsible for the schemes get actuarial valuations. The new guidance will increase pension liabilities.
Actuaries have been caught out by startling falls in death rates among older people. In the 1980s life expectancy for men aged 65 rose by a year. In the 1990s it went up by two years, and official forecasts suggest that it will increase by 2.5 years in the current decade. Gains for women aged 65, who live longer than men, have been less dramatic -an extra year a decade in the 1980s and 1990s -but they have also picked up, to 1.5 years, in the 2000s.
These big improvements reflect especially steep falls in death rates for people born between 1920 and 1945. A crucial question is how much longer this "golden cohort" will lead the way to lower mortality. According to the regulator, 55% of pension schemes have been assuming that the big declines in death rates will taper away to more normal falls by 2020; 11% that they will fade by 2010; and virtually all the others have paid no heed to the phenomenon.
The watchdog wants schemes to pick 2040 as the date when the golden cohort’s super-fast mortality reductions draw to an end. It is also serving notice on valuations that assume an eventual end to improvements in longevity. Instead they should allow for future falls in death rates of at least 1% a year. The scope for further gains in life expectancy is clear in the gap between Britain and other countries where longevity is higher, especially for women.
The new guidance may be more realistic but it will be a cold shower for firms with finalsalary schemes. It will raise life expectancy assumptions for people retiring today by two to three years. According to the regulator, an increase of a year pushes up pension-scheme liabilities by 2.5%, which suggests that they would rise by between 5% and 7.5%. Some accountancy firms even think that the liabilities will rise by as much as 10%.
The watchdog’s tough line on longevity is not the only worry for firms with final-salary schemes. In a recent discussion paper, the Accounting Standards Board called for the discount rate, which is used to calculate the present value of future pensions, to be based on government rather than high-quality corporate bonds. This would push up pension-scheme liabilities, which vary inversely with the discount rate, because gilts are safer than company debt and so have a lower yield.
Like the regulator’s guidance on longevity, the ASB’s proposal injects realism. If companies generally become more likely to default, then corporate-bond spreads -the extra interest they pay compared with gilts -will rise. Perversely, that will shrink pension-plan liabilities even though the firms backing the schemes have become less creditworthy.
It will take several years for the ASB’s new approach, if adopted, to affect company accounts. Yet, together with the regulator’s move on longevity, the reform could have an unfortunate consequence for pension-scheme members. More firms may conclude that maintaining a defined-benefit scheme -even one closed to new members -is the financial equivalent of running up the down escalator.
We can infer from the passage that the "golden cohort"().
A. will lead the way to lower mortality until 2020
B. will decline in death rates by 2010
C. will not suspend the quick mortality reductions until 2040
D. None of the above
