(Bloomberg) — 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 $4.5 billion to $30.5 billion while shareholders in International Business Machines Corp. saw their equity shrink by around $6 billion.
“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.