Perspectives

Groundhog Day Meets Mortality Assumptions

shutterstock_526646212

Perhaps it would have been more fitting if the Society of Actuaries published their updated pension mortality improvement scale, MP-2018, on February 2. (For readers unfamiliar with the 1993 movie, Phil (Bill Murray) is stuck in a time loop, reliving one particular day – Groundhog Day.) By our estimates, the updated tables reduce the typical pension plan liability by about 0.4%. MP-2018 is a repeat of the prior three year’s downward trend that has cumulatively reduced pension liabilities by approximately 3%, with the zenith of longevity optimism occurring with the release of MP-2014.

We recently presented a version of the chart below (Figure 1) at the 2018 P&I Risk Strategies conference. The chart shows the impact of recent updates to the pension mortality improvement scale through MP-2018.

This most recent update provides an opportunity to reiterate two key points when thinking about longevity risk, and adds one additional thought to ponder.

  1. Do not confuse the mean with the variance. The average increase in the life span of pensioners is not longevity risk – it is in fact expected. We need to measure the risk around our baseline estimate in expected longevity improvements. We believe this risk to be modest.
  2. Longevity risk is symmetric. Or, at least there is no reason to believe there is any meaningful asymmetry. Once we adequately account for the trend improvement (point #1), this becomes quite apparent. The recent updates provide a good example of downside risk to longevity (or upside risk to pension funded status).
  3. Despite the last point, the last four updates have been revisions downward. Does this suggest a trend in the trend updates? That is too hard to say, but 4 draws on one side of the distribution sounds like a 1 in 16 event – that is unless there is a bias at work here.

None of these points should be construed as an argument against hedging longevity risk. Rather, given the size of the risk, we believe a plan should not pay much for such a hedge (or ideally, be paid.) Accordingly, we are ardent supporters of the development of a longevity swap market in the U.S. Unfortunately, in our (limited) attempts to procure such hedges, the costs were not justified relative to the magnitude of the risks.

One related point for plans that are considering a pension buyout: it is important to revisit the mortality assumptions being used in the economic evaluation. Namely, such assumptions may be stale or not relevant for the demographic group being evaluated. To underscore this fact, we point to the following comment in the SOA’s release:

“In MP-2018, we see continued reduction of overall U.S. mortality improvement trends that we started seeing in 2010,” said Dale Hall, Managing Director of Research for the SOA. “However, because we are also continuing to see varied mortality improvement across the age groups, it’s imperative for industry professionals to perform their own calculations, using the demographics of their pension population to determine the impact of implementing MP-2018 on their individual plan.”

We found this comment very interesting and consistent with another recent post of ours. The “varied” nature of mortality improvement seems consistent with a growing range of life expectancy. We think this is a particularly important point for plans considering small balance buyouts, as we recently pointed out.

Disclaimer: By accepting this material, you acknowledge, understand and accept the following:

This material has been prepared by NISA Investment Advisors, LLC (“NISA”). This material is subject to change without notice. This document is for information and illustrative purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action, including without limitation as those terms are used in any applicable law or regulation. This information is provided with the understanding that with respect to the material provided herein (i) NISA is not acting in a fiduciary or advisory capacity under any contract with you, or any applicable law or regulation, (ii) that you will make your own independent decision with respect to any course of action in connection herewith, as to whether such course of action is appropriate or proper based on your own judgment and your specific circumstances and objectives, (iii) that you are capable of understanding and assessing the merits of a course of action and evaluating investment risks independently, and (iv) to the extent you are acting with respect to an ERISA plan, you are deemed to represent to NISA that you qualify and shall be treated as an independent fiduciary for purposes of applicable regulation. NISA does not purport to and does not, in any fashion, provide tax, accounting, actuarial, recordkeeping, legal, broker/dealer or any related services. You should consult your advisors with respect to these areas and the material presented herein. You may not rely on the material contained herein. NISA shall not have any liability for any damages of any kind whatsoever relating to this material. No part of this document may be reproduced in any manner, in whole or in part, without the written permission of NISA except for your internal use. This material is being provided to you at no cost and any fees paid by you to NISA are solely for the provision of investment management services pursuant to a written agreement. All of the foregoing statements apply regardless of (i) whether you now currently or may in the future become a client of NISA and (ii) the terms contained in any applicable investment management agreement or similar contract between you and NISA.

NISA Investment Advisors, LLC is an independent, employee owned investment management firm. We focus on risk-controlled asset management for large institutional investors.

Content © 2008–2020 NISA Investment Advisors, LLC.

NISA Investment Advisors, LLC
101 South Hanley Road
Suite 1700
St. Louis, MO 63105-3487
P: 314.721.1900
F: 314.721.3041

Agree to Terms

Please review and accept the following to proceed.

I have read and agree to the Terms of Use, Disclaimer, PSRX Disclaimer, and Privacy Policy. I am either (i) an investment professional and an employee of an institutional investor, or a consultant to an institutional investor, or (ii) an employee of, or a student in, an institution of higher learning and I am involved in the study, research or teaching of subjects related to investments, finance, or economics. I reside in the United States or Canada. I understand that the information is not and should not be regarded as investment advice or as a recommendation regarding a course of action.

By clicking “Accept” below, you hereby acknowledge, understand and accept the foregoing.