The market shift towards defined contribution schemes will accelerate over the next few years due t...
The market shift towards defined contribution schemes will accelerate over the next few years due to the lengthening mortality of pensioners, according to Phillips & Drew.
The group said an unprecedented surge in mortality improvements in the generation of people at or nearing retirement has not been fully recognised by many pension schemes, with some underestimating liability by up to 30%.
This is leading many employers to look at defined contribution schemes in order to lessen the liability in matching increasing pension contributions.
It could also lead to a cessation of pension contribution holidays as funding needs increase. In the group's report, Pension Fund Indicators - a long term perspective on pension fund investment, it notes that people born after 1925 enjoy life expectancy increases at a faster rate than previous generations.
This is leading to rapidly rising contribution levels to maintain current benefit levels.
The effect of this will be exacerbated by the declining returns on fixed interest investments such as gilts, producing what Andrew Maclaren, a director at Phillips & Drew describes as a double whammy effect, reducing absolute returns in two separate hits.
He said this double effect will have a defining influence on the shape of the occupational pension scheme market.
Maclaren said: "People born between 1925 and 1945 have benefited from faster mortality improvements than those born in adjacent generations. These are the people who are close to retirement or who have already retired.
This means that post-retirement lifespan, which has been improving over the years, is now likely to increase sharply."
To illustrate how high the costs can be, Maclaren said that paying an inflation-linked pension for 25 years rather than 20 years leads to a rise in costs of 20% at prevailing 2% real interest rates. He said some schemes have already made allowance for mortality improvements but many did not fully understand the scale of the problem.
However, he does not believe that problems due to improved mortality will lead to any schemes going bankrupt. The costs, he said, will mount gradually putting pressure on defined benefit pensions, and individual scheme's operations will have to alter to absorb those costs.
He said: "To some extent I think people have seen it coming, but felt it wasn't such a problem because it could be covered by other factors like high returns on investments. However, now there is a double whammy. Returns on investments are low, particularly on bonds, and people are living longer." He said: "The funds will have to allow for the fact that people are living longer and so savers will have to put more money into their pensions.
The effect is the same to cover the reductions in returns from investments."
He added that this was likely to lead to an end to contributions holidays offered on pension schemes, and would see companies facing large increases in wage bills as they are forced to match employee's contributions.