Managing longevity risk

Abstract

Introduction Defined benefit pension schemes face a wide range of risks which can broadly be classified under the headings of market risk, operational risk and insurance risk. The latter comprises a whole host of risks affecting the demography of the scheme, arising from human contingencies and member options. Amongst them is the risk of scheme members outliving expectations – longevity risk. As pension schemes have grown and matured, so has their longevity risk, and as schemes have taken steps to reduce their financial risk, their longevity risk has become proportionately greater. In many schemes it now represents a significant proportion of the total risk. At the end of 2008, the pension schemes of the FTSE 100 companies were in aggregate taking half as much risk from longevity as they were from exposure to equity markets (see Figure 13.1). Compared with inflation and interest rate risk, the proportion was even higher – nearer two-thirds. While these proportions do vary from scheme to scheme, there is little doubt that for many schemes their exposure to longevity risk is significant, and perhaps takes up a disproportionate share of the risk budget.