Earlier this year, data from the UK’s Continuous Mortality Investigation Mortality Projections Committee showed that life expectancy improvements have slowed dramatically. Initially thought to be a blip in the data, there is increasing evidence, both in the UK and in other developed countries, that this is a structural change in the trend, something that should benefit those UK companies with large defined benefit pension deficits.
Old age life expectancy has been improving in the UK since the 1960s, as medical advances, particularly in the treatment of cardio-vascular diseases and cancer, together with the decrease in smoking, took effect. However, while deaths from cardio-vascular diseases have continued to fall, since 2011 the rate of decline has slowed significantly, on top of which, deaths from dementia and obesity-related diseases have increased. (Dementia UK forecasts over one million people will have dementia by 2025, growing to over two million by 2051.)
What does this mean for companies with large defined benefit schemes which set aside a sum of money now (the reserve) to pay each scheme member’s benefit for the rest of the member’s life?
Analysts at RBC Capital Markets have crunched the numbers. They found that most companies use older mortality tables to calculate their reserves. Therefore, the lower life expectancy shown in the (most recent) 2016 mortality tables is positive for UK pension schemes as the benefit will be paid for fewer years than currently allowed for in companies’ reserves. In addition, these tables underestimated recorded deaths in 2016 by 4%, a significant proportion. The 2017 mortality tables (due to be published in March 2018) are expected to show a continuation of the downward trend. According to the analysis, at the individual company level, BT and Marks & Spencer look to gain the most from this.
The analysis also showed that the aggregate UK pensions deficit has already improved dramatically over the last 12 months. Equity markets, which still account for 30% of pension fund assets, have performed well and the calculations (on an IAS 19 basis) indicate that the deficit of the FTSE 100 has improved significantly from the record post-Brexit level of £103bn on 11 August 2016 to £17bn as at 31 July 2017 (one-sixth of the level a year ago).
Overall the shares of companies with significant defined benefit pension schemes have underperformed the wider equity market by 5% pa over the last three years and by 11% since the Brexit vote. Pension schemes can often be overlooked by shareholders and it is likely that the significant reduction in the aggregate deficit over the last 12 months has not been fully appreciated. On top of this, the gains from moving to the up-to-date mortality tables should further shrink the pension hole, a positive outcome for many FTSE 100 companies.
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