People are living longer -- and that’s bad news for some companies’ bottom lines.
As pension plans incorporate new life-expectancy estimates into their calculations, investors are glimpsing the financial fallout from aging societies.
AT&T Inc. last month absorbed a $7.9 billion non-cash charge from rising pension costs, including retirees’ longer lifespans. At Northrop Grumman Corp., updated mortality estimates boosted its pension obligations by $1.8 billion to $30.5 billion, while shareholders in International Business Machines Corp. saw their equity shrink by around $6 billion after the company recalculated its pension bill, in part because of the mortality changes.
“2014 was a tough year for pension plan sponsors,” said Matt Herrmann, a senior consultant for Towers Watson in St. Louis. “Folks are going to continue to live longer. That means a significant increase in pension liabilities.”
To avoid ballooning costs from years of additional pension checks, some companies are paying insurers to take over their plans. Life insurers see the longevity deals, which expose them to financial risk if people live too long, as balancing their existing exposure to paying if customers die too soon.
In September, Motorola Solutions Inc. cut its pension obligations by $4.2 billion by transferring responsibility for 30,000 retirees to Prudential Financial Inc. and offering others lump sum payments. Now, if Motorola retirees live longer, Prudential will be on the hook, not their former employer.
Dozens of additional deals are likely this year. In a MetLife Inc. survey of 228 pension plans, 29 percent said they are considering similar transactions over the next two years.
Demand for such pension risk transfer deals eventually will eclipse the insurance industry’s capacity and provide an opening for investment banks to sell securities known as “death derivatives,” some experts say.
“The capital markets are going to have to come in because there’s not enough capacity from insurers and reinsurance companies,” said Rosemarie Mirabella, assistant vice president for A.M. Best Co., a global credit-rating agency in Oldwick, New Jersey.
Before the financial crisis, investment banks such as JPMorgan Chase & Co. and Morgan Stanley joined an industry association designed to promote standardized securities that would package the risk of pensioners living longer than expected. Such longevity bonds could appeal to sovereign wealth funds, hedge funds and endowments looking for investments that aren’t correlated with other asset classes.
Deutsche Bank AG completed the first longevity deal involving third-party investors in February 2012. In a 12 billion euro ($13.6 billion) swap with Aegon NV, a Dutch insurer, Aegon paid Frankfurt-based Deutsche Bank a fee to assume some of its pension risk. The bank then sold the risk to investors, who receive a floating payment from the bank based on how quickly pensioners die relative to an index.
The pension risk market won’t really take off until interest rates rise and make such deals less expensive.
The trigger for corporate pension plans to update their lifespan assumptions was the October release of new mortality tables from the Society of Actuaries in Schaumburg, Illinois. Starting in 2009, society researchers pored over private pension plan data on 220,000 deaths and 10.5 million life-years, said Dale Hall, the society’s managing director for research.
The new estimates, the first update since 2000, were designed to provide more realistic guidance for plan sponsors who have generally done a poor job of keeping pace with the steady improvement in life expectancy in recent decades.
A 65-year-old male now can expect to live 21.6 additional years, two years longer than in the old tables.
Publication of the new tables -- a standard reference for plan sponsors -- began having a financial impact in fourth-quarter earnings statements.
General Motors Co. said on Feb. 4 that the new mortality data added $2.2 billion to its already underfunded pension liabilities.
Along with longer lifespans, pension plans suffered last year from falling interest rates. For most plans, the impact from lower rates, which makes it harder to earn money to pay future benefits, exceeded the price tag associated with updated mortality assumptions.
Three-quarters of the $3 billion increase in Dow Chemical Co.’s pension liabilities came from lower interest rates; the remaining $750 million stemmed from new lifespan estimates, the company said.
The typical corporate pension plan already is underfunded. In aggregate, plans maintained by the 411 companies in the Fortune 1000 that sponsor defined-benefit plans -- where retirees receive a guaranteed payout depending upon years of service -- are 80 percent funded, according to Towers Watson.
That’s down from 89 percent at the end of 2013, reflecting the impact of falling rates and the new life-expectancy projections. The cumulative funding deficit stood at $343 billion at the end of 2014.
At Weyerhaeuser Co., in Federal Way, Washington, the new mortality estimates accounted for about $400 million of an $820 million increase in its plan’s deficit at the end of 2014.
Premiums for government insurance that covers benefits checks in the event of plan failure also rose.
Interest rates will eventually reverse course; ever-longer lifespans won’t. Accurate lifespan projections are thus crucial to pension plan management.
If retirees on average live three years longer than expected -- a typical margin of error in the past -- a global pension bill estimated at up to $25 trillion could swell by $3 trillion, according to a 2013 report by the Bank for International Settlements’ Joint Forum, a global body of insurance, banking and securities regulators.
Companies in the U.K., where benefits are indexed for inflation and mortality estimates are updated annually, have been more aggressive at shifting pension risk. In the U.S., less than 5 percent of roughly $3 trillion in defined-benefit obligations have been offloaded, said Herrmann.
Companies are caught between the dangers of retaining pension risk and the cost of unloading it.
Standing pat increases share price volatility and the cost of capital, says Amy Kessler, senior vice president for Prudential Retirement.
Interest rates must rise by at least 1 percentage point to make deals affordable.
“The low rates have been the most common deterrent to de-risking,” she said.-