Longevity risk seen big issue for UK pensions in 2007

Companies running pension funds will find it harder to ignore Britain's rising longevity in 2007, while pension liabilities will continue to be significant in merger tussles, industry figures say. Longevity risk - the chance that a pension fund may run short of money because people live longer - is probably the biggest challenge facing Britain's corporate pensions next year, Peter Redhead, managing director at Pension Capital Strategies, told Reuters.

"Auditors are becoming aware of it and starting to question what it (mortality) does to liabilities. To date, because it has not been necessary to disclose mortality assumptions, many companies have just buried their heads in the sand."

Consultants also said pensions would remain a significant element of merger and acquisition cases and that recent enthusiasm for alternative assets such as private equity may wane if returns run into headwinds.

How pensions handle longevity risk, however, was the most common talking point for consultants and analysts who gave Reuters their predictions about Britain's corporate pension industry, estimated by Swiss bank UBS to hold about £750 billion of assets in 2005.

"The profile (of longevity risk) is a lot higher than it was six or even three months ago. The major auditors are all discussing this question," PCS's Mr Redhead said.

The deficit in final-salary pension plans of Britain's top 100 listed companies could be more than £100 billion, about £60 billion more than current estimates, because firms have underestimated longevity, PCS said in October.

A British man aged 65 by the middle of this century, for example, will expect to live for nearly another 20 years, compared with 12 years in 1950, according to the UK Government Actuary's Department.

Pension liabilities are likely to play an important role in M&A tussles, because deficits, which are accounted for like debt on company balance sheets, can affect the price of a target firm or even kill off deals, said Paul Jayson, a partner at actuaries and consultants Barnett Waddingham.

"(Some) companies don't want to look at any pension scheme risk."

In April, Spanish construction firm Grupo Ferrovial, which later bought airport operator BAA, held talks with BAA's pension trustees as part of its negotiations.

The new Pension Regulator, which has the power to make companies shoulder their pension obligations, is still looking to see how far it can go in wielding its power, said Con Keating, principal of the Finance Development Centre, a research organisation.

"The Regulator is still young, and any such regulator is at odds with its constituency in its early days."

Mr Keating expects no major shift in the trend away from defined benefit pensions in 2007.

Nearly two-thirds of UK defined-benefit pensions are closed to new recruits, according to data in 2005 from the National Association of Pension Funds, which represents schemes with combined holdings of more than £700 billion of assets.

Next year may be a hard test for a buyout firms offering to insure companies' pension liabilities, Mr Keating said. "If they don't write some serious business, they are going to get flak from people with equity (in the buyout funds)."

New buyout firms include Paternoster, founded earlier this year by former Prudential Plc Chief Executive Officer Mark Wood.

Mr Keating, a critic of the UK accounting rule that uses bond yields to calculate liabilities, also said the industry will watch to see if the Accounting Standards Board (ASB) proposes to change the rules.

Accounting standards can have a dramatic impact on pension liabilities, because even a small movement in bond yields, for example, can push a retirement plan sharply into the red. Mr Keating also doubted that pension plans would continue to pour money into alternative areas including hedge funds that they have in recent years, because returns have become lacklustre in some products.

Kevin Wesbroom, a principal consultant with Hewitt Associates, said the industry may be surprised by a switch into surplus and that fund trustees may not know how to respond.

"People will say, 'Well, what do we do with it'?" he said. Some funds may carry on investing, while others use a surplus to buy out a another plan via the annuity market, he said.