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Pension Plan Sponsors Need to Manage Longevity Risk

The underestimation of human life spans by forecasters and the potentially sharp unanticipated increases in longevity resulting from medical breakthroughs poses a real risk to pension funding levels, a new report notes.

By PLANSPONSOR staff editors@plansponsor.com | November 16, 2016
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The dramatic rise in life expectancy has improved human well-being but future longevity uncertainty also poses a real challenge to pension funding levels that plan sponsors will need to proactively manage, says a report by PGIM, the global investment management businesses of Prudential Financial, Inc.

The report, “Longevity and Liabilities: Bridging the Gap,” highlights that longevity risk has often taken a backseat to investment and interest rate risk. The underestimation of human life spans by forecasters and the potentially sharp unanticipated increases in longevity resulting from medical breakthroughs, such as anti-aging genetic treatments, poses a real risk to pension funding levels. This risk is compounded by the “lower for longer” interest rate environment that has burdened plan sponsors with low discount rates.

“We have had a century of underestimating actual longevity experience,” says Taimur Hyat, PGIM’s chief strategy officer. “These annual forecasting errors can compound over time to be quite significant. Understanding, quantifying the true magnitude, and responding to the challenge of longevity risk is an important step for plan sponsors.”

"We evaluated the potential impact of further increases in life expectancy on liability values and found that longevity risk can be significant for certain plan profiles," says Karen McQuiston, head of PGIM’s Institutional Advisory and Solutions team. “We would encourage plan sponsors to incorporate these potential dynamics into their risk management processes and recommend that plan sponsors measure and manage longevity risk, inflation risk, and interest rate risk in an integrated framework."

While changes in longevity can materially affect the pension liabilities of all sponsors, the impact is magnified for pension plans with cost of living adjustments or inflation indexation, including many U.S. public pensions and U.K. public and corporate plans. In total, unmanaged longevity risk has the potential to worsen a plan’s risk profile, reduce funded status and lead to unforeseen costs, PGIM says.

NEXT: Suggestions for managing longevity risk

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