Newspaper article The Evening Standard (London, England)

Pension Funds Face Poor Health as Lives Get Longer

Newspaper article The Evening Standard (London, England)

Pension Funds Face Poor Health as Lives Get Longer

Article excerpt


THE Financial Services Authority has warned insurance companies to make sure they are not caught out by people living much longer than hitherto, and therefore collecting far more on their annuity contracts than the companies had expected or could afford. The FSA is worried that mis-pricing of annuities - in other words agreeing to pay out too much for too long - could force some firms into insolvency.

If this might be a problem for insurance companies - and the Equitable Life experience suggests it is, given that longevity was as much a cause of its ills as were falling interest rates - how much more of a problem might it be for final salary pension schemes? All the factors that would cause an insurance company to underestimate the impact of increased life expectancy are present in company pension funds.

Indeed, it is worse. Companies make an open-ended commitment to pay a percentage of final salary every year to their members once retired, and to their spouses, and that means they have to find the necessary capital to fund the exercise. If that is handed over to an insurance company to buy the member an annuity, the risk passes to the insurance company, as the FSA says.

But not all companies buy open market annuities for their retiring members.

Quite a few pay the pensions out of internal cash flows within the pension fund. They therefore retain the risk of people living a long time and they are every bit as vulnerable to a financial squeeze.

This will cause an interesting generational choice. If topping up the pension fund to keep it solvent risks putting the sponsoring company into financial difficulties, what should a board do? Given that there is not enough money to satisfy everybody, who is more important - the retired workers and members of the fund or the current generation of employees? …

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