Pensions accounting experts have warned of a “lost decade” in mortality improvement among members of UK defined benefit (DB) pension schemes.

According to KPMG’s latest Pensions Accounting Survey of UK DB plans, life expectancy projections fell over the course of 2018 for the fourth year running. 

The survey examined pensions accounting assumptions used by 212 KPMG clients reporting under International Financial Reporting Standards (IFRS), UK GAAP and US GAAP rules.

KPMG’s pensions director Naz Peralta told IPE: “With the release of CMI [Continuous Mortality Investigation] 2018, 2019 will see assumed life expectancies under IFRS hit the same levels we saw in 2009 – a lost decade of life expectancy improvements.

“The latest CMI 2018 model is showing that life expectancy improvements are lower than anticipated by the previous CMI 2017 model. The models reflect the recent actual outturn in improvements within the population.”

The figures mean that, for someone currently aged 45, their assumed pension scheme life expectancy at age 65 will fall to around 23 years in 2019 – a level last seen in 2009.  Between 2012 and 2015, assumed life expectancy was roughly one year higher at just over 24 years.

“Given the market volatility, it is mortality assumptions and deficit contributions that are more reliably reducing reported deficits”

Naz Peralta, KPMG

For a pension scheme member already aged 65, assumed life expectancy in KPMG’s survey has fallen to 21.9 years, the lowest since 2010.

Peralta added that most sponsors were updating CMI models regularly in their calculations, meaning that balance sheet positions have improved over the past year.

However, he also warned that, although some larger DB schemes have hedged mortality using longevity swaps, many of those contracts were significantly out of the money because they were transacted at a time when longer life expectancy was being priced in by the providers.

KPMG Pensions Accounting Survey highlights

  • Median discount rate assumption up from 2.5% last year to 2.9% at 31 December 2018
  • Long-term inflation expectations stable over the year with a median assumption of 3.3%
  • Median life expectancy down 0.2 years for current pensioners, and 0.1 years for future pensioners.
  • Median impact of GMP equalisation is 0.7% of the total DB liability

Little impact from discount rates

Meanwhile, neither discount rates, inflation nor investment returns emerged in the survey as a standout influence on UK DB pension liabilities over the past year.

Corporate bond yields – and therefore IAS 19 discount rates – increased by roughly 0.4% over 2018, with the survey recording median rates of 2.5% at the end of 2017 and 2.9% at the end of 2018.  

Peralta said: “Over 2019 year to date, discount rates have probably lost all of those gains, and we are certainly seeing market volatility linked to political and economic uncertainty.

“So while discount rates contributed to balance sheet gains over 2018, given the market volatility it is actually mortality assumptions and deficit contributions that are more reliably reducing reported deficits.”

Median RPI inflation assumptions remained unchanged as of 31 December 2018, at 3.3%.

Only Gilts were in positive territory during 2018 among the main asset classes, KPMG reported, with most other asset classes posting relatively poor returns over the period.

“Equity returns have bounced back quite significantly in both the UK and elsewhere over 2019,” Peralta said. “In addition, falling fixed interest yields are a product of increasing bond and Gilt values.”

Guaranteed minimum pension equalisation

Another positive development revealed in the survey was that the effect of accounting for the impact of so-called guaranteed minimum pension (GMP) equalisation was likely to be far less onerous than first feared.

KPMG’s researchers found that 70% of the sponsors in the 2019 survey recorded a liability increase of less than 1%, with 13% reporting an increase of less than 20 basis points.

The issue of GMP equalisation hit the headlines in October last year when the UK’s High Court ruled that the payments – which date back to 1990 – must be recalculated to ensure men and women are paid equally.

Prior to the ruling, which was based on Lloyds Banking Group’s DB schemes but is expected to affect the majority of DB schemes in the UK, commentators put the cost of GMP equalisation at roughly 1-3% of liabilities, while some estimates were as high as £32bn (€37bn).

Peralta said: “The Lloyds case outcome was based on the principle of minimum interference, ie that the sponsor could direct the trustees to use the minimum cost method that was legally valid, which has helped to bring the costs down.

“Our experience has been that the schemes with the highest uplifts – say, at 2% of liabilities or higher – are those with the least generous retirement benefits, typically higher retirement ages and/or lower pension increases.

“Similarly, those that can expect the lowest bills for GMP equalisation tend to have the most generous benefits for 1990-97 service, such as retirement age rights at 60 and RPI-linked pension increases.”

Nearly all of companies surveyed by KPMG have recorded the cost of GMP equalisation as a past service cost in their profit or loss accounts.