Is the PPF ready to hedge longevity risk?

 

 

 

 

The Pension Protection Fund (PPF) reached an impressive funding level of 115% at the end of March this year. Its 2014/15 annual reports and accounts - published on 20 July - showed its surplus was £3.6bn.

The lifeboat fund now owns and manages assets of £22.6bn. Over the past ten years, it has collected levies worth £5.3bn; transferred in assets of £8.7bn from schemes in deficit; and recovered £1.9bn from insolvent scheme sponsors.

But despite its progress since its inception in 2005, the fund has actually cut expectations that it will reach self-sufficiency by 2030 from 90% last year to 88% this year. Part of the reason for this has been the significant surge in deficits across the defined benefit (DB) schemes in its universe.

In January, the total deficit of schemes in the PPF 7800 Index was a record high of £367.5bn on an s179 basis. Since then however, there has been a consistent reduction in deficits. The figure recovered to £223.1bn in June.

This demonstrates the ever-shifting environment in which the fund has to manage its liabilities. Chief financial officer Andy McKinnon says the fund is operating in "an outside world that continues to be uncertain".

As such, it is only logical to ask whether the PPF should consider insuring its liabilities; how it could achieve this; and if there were any reasons why it should not.

JLT director Martyn Phillips points out the PPF already hedges its investment risks; interest rates and inflation. That leaves longevity as the big unknown. As such, the PPF could consider a longevity swap as a way to manage the risk or look to do transactions on either the buy-in or buyout market for even more robust protection.

Although Phillips agrees that a buy-in could be a viable de-risking tool for the PPF, he is against the idea of the government-backed fund entering a buyout. Phillips says: "I suppose it goes back to the principle of why the PPF is there.

"It's a backstop and the scheme of last resort so for the PPF to pass on responsibility for pension scheme members that have had to rely on it to provide their benefits, I think would be very challenging.

"A buyout would be nigh on impossible from a principle's perspective. But a buy-in or a longevity swap are really to my mind just de-risking tools. The PPF has a stated self-sufficiency objective and it also adopts quite a low risk approach to how it invests to back its liabilities.

"One could argue that it may at some point in the future look to undertake a buy-in or a longevity swap to lock down and protect part of the risk it's holding today to get it closer towards the self-sufficiency goal."

LCP partner Charlie Finch agrees that a buy-in is a potential way forward for the lifeboat fund. But he is against the idea that moving the liabilities onto an insurer goes against the funds' principles. After all, plenty of other government-backed organisations outsource their responsibilities to the private sector.

Finch says the key consideration for the PPF is whether a buy-in offered good value. Transaction costs are more favourable where the money has been invested on a low-risk basis too.

The fund would need to split its liabilities into blocks and decide which parts were better managed in-house and which would be better off under the control of an insurer, according to Finch.

He adds: "In my view the PPF should certainly consider longevity hedging or buy-in options as a way of managing the risk and making sure it delivers value for levy payers. There's no ethical reason why it shouldn't be outsourcing these things to the private sector."

According to the PPF long-term funding strategy update - published on 27 July - its statement of investment principles has been updated to allow investment in long-term illiquid assets with hedging properties. The fund has already begun the transition to this strategy. Overall portfolio allocation to illiquids has risen to 12.5%.

Hans den Boer (pictured) was named chief risk officer in February. The appointment reflected the growing importance the lifeboat fund places on implementation of best practice as it expands. Den Boer does not rule out some sort of insurance based de-risking in the future.

He tells PP: "There are some risks which will remain beyond 2030 and which we will need to hold reserves against, such as unexpected claims, CPI/RPI mismatch and operational risk.

"The largest risk which at present we need to target holding a reserve against is members living longer than expected.

"If we believed the costs of transferring longevity risk provided value for money, and the additional risks associated with the transaction (for example counterparty risk) were within our risk appetite, we would derisk. We do keep under review whether we could do this but wouldn't currently do so."

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• Topics
• Risk Reduction
• PPF
• buyout
• Longevity swaps
• JLT
• LCP