Weighing the Pension Investment Implications of Mortality Assumption Changes

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On October 27, 2014, the Society of Actuaries published final reports that essentially reaffirmed the findings of its February 2014 preliminary mortality experience study. While the precise impact and timing will vary by plan sponsor (and potentially by plan auditor), the adoption of such mortality assumptions will undoubtedly increase pension plan liabilities and durations. With an appreciation for the interdependence of both sides of the balance sheet, this paper focuses specifically on the investment considerations associated with such a change in mortality assumptions used for calculating pension liabilities.

In summary:

  • The new mortality assumptions reflect improved longevity and will therefore result in increases to both pension liabilities and plan durations.
  • Lower plan funded statuses (due to pension liability increases) theoretically provide incentive to re-risk asset allocations, while longer plan durations suggest de-risking is more appropriate.
  • Sponsors may prefer to re-risk with respect to equity exposure while de-risking with respect to duration mismatch, which is achievable using either derivatives or cash bond alternatives such as U.S. Treasury STRIPS.
  • The investment decision requires a fundamental choice on whether to accept, intensify, mitigate or shift the incremental funded status volatility associated with lengthened liability duration.
  • In light of the mortality changes, we believe sponsors should review their strategic asset allocations, benchmarks (particularly with respect to duration), contribution policies and glidepaths to ensure optimality based on all available information.

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