EUROPE - Pension funds' "exposure to longevity risk" is still the main liability issue facing pension funds today, Professor David Blake, director of the Pensions Institute at Cass Business School, has warned.
A lack of preparation and funding for increased longevity means pension funds will struggle when the market for longevity risk grows rapidly over the next few years, according to Professor Blake, who was one of 12 nominees for the Outstanding Contribution Award at IPE's European Pension Fund Awards 2008 hld in Barcelona last night.
Speaking ahead of the event, Blake told IPE: "Trustees and sponsors do not fully understand this risk and what they need to do to manage it. They certainly haven't funded for increased longevity and the market for managing longevity risk is only just getting off the ground."
The two things needed to start the market, according to Blake, are "longevity indices" that can be used to design and trade longevity-linked instruments and the development of "stochastic mortality models" to help quantify longevity risk.
JP Morgan, the Pensions Institute and Watson Wyatt are already doing the former through their LifeMetrics Longevity indices, and the second concept is also being worked on.
Blake believes companies may have to rethink their pension plan and take drastic measures to reduce liabilities.
"The big increase in pension fund deficits will mean that companies are either going to have to put more money into their plan or find ways of reducing their pension liabilities, such as asking members to work longer or accept lower pension benefits," he said.
Another critical issue facing pension funds is the collapse in value of their holdings as a result of falling global equity markets and freezing corporate bond markets.
"In the long term, equities have outperformed bonds, but equities have become very volatile over the last decade with three large stock market crashes. Equities are proving to be a less reliable investment product than they have historically", said Blake.
As a result, pension funds have moved towards bonds, especially corporate bonds, in an attempt to reduce volatility without sacrificing yield.
However, "liquidity of the corporate bond market has dried up" said Blake, who believes it could take up to two years for the global financial system and economy to recover.
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