Top Charts 21-12: longevity as a proportion of total funding risk for Canadian pension plans

Question:

What proportion does longevity make-up of the total funding risk of pension plans in Canada?

Answer:

Over the past 15 years, pension plans in Canada have tended to reduce their exposure to asset risk and hedge their exposure to volatility in funding yields. In fact, a recent study by Bank of Canada shows that about 64% of Defined Benefit (DB) pension plans have shifted their asset allocation more toward bonds (and away from equities) between 1998 and 2018. A similar de-risking pattern was also observed among defined benefit pension plans in the UK as highlighted here .

Change in asset split between equities and bonds for Canadian pension plans

^{Source: Office of the Superintendent of Financial Institutions pension fund data. Details of portfolio shift metric can be found in the Bank of Canada analytical note available here .}

This has left longevity risk as the largest remaining unhedged risk; in fact, the remaining unhedged longevity risk can potentially make up over 60% of the total funding risk.

Change in composition of funding risk for Canadian DB pension plans

^{Source: Club Vita analysis based two hypothetical plans. Charts have been provided for illustration purposes only.}

Typical 2006 plan

• 80% funded with 65% pensioners & 35% non-pensioners to represent a mature underfunded plan
• 60% equities and 40% bonds, with the bonds having an interest/inflation exposure matching the liabilities

Typical 2018 plan

• 100% funded with 70% pensioners & 30% non-pensioners to represent the same plan a few years later after the plan has further matured
• 20% equities and 80% bonds to capture that the plan has de-risked their asset mix systematically over this time

The key questions is: How should pension schemes most effectively hedge this longevity risk?

What do you think?