The cost for pension schemes hedging longevity risk has increased by 50% as a result of record low gilt yields after Brexit, data shows.
According to Hymans Robertson, the amount of money defined benefit (DB) schemes need to hold to pay pensions for scheme members’ lifetimes has increased because yields have plummeted further since their already low levels following the UK vote to leave the European Union on 23 June.
The consultant warned the situation could get worse over the coming months if the Bank of England reduced rates even further.
Hymans Robertson chief investment officer Andy Green, explained: “Any trustee or plan sponsor will know that the fall in yields weighs heavily on the cost of pension fund provision. The continued erosion of interest rates over the past 12 years has already hit pension schemes hard. Scheme liabilities have increased by 50% over that timeframe to £2.3trn.
“What many don’t realise is that interest rates and longevity risk are highly correlated.
“When interest rates were much higher, if people lived one year longer than expected, this increased the cost of providing their pension by around 3%. However, with real yields on index-linked gilts now below 1%, more money needs to be held today to pay a year’s pension in 25 years’ time than is needed to pay next year’s pension.
“Consequently a one-year change in life expectancy is now more likely to add 4.5% to the cost of paying a pension for someone’s lifetime. That’s a 50% increase in longevity risk.
“In combination with the increase in liabilities, there has been a 125% increase in like for like longevity risk in pound terms.”
Hymans Robertson head of risk transfer solutions James Mullins said it was “inevitable” longevity risk would move higher up the agenda for those running DB schemes.
He added: “This increase in the cost of longevity risk comes at a time when, due to schemes maturing, they’ve been dialling down their exposure to investment risk. This means that longevity risk now represents a larger risk than ever before for DB pension schemes.”
