15 December 2020
How long are you going to live? Has Covid-19 impacted that prediction? And how will that change in the future?
Nobody knows the answer to the first question for sure. And it’s probably too soon to say much about the other two.
However, at this time of year lots of company directors have to answer these questions for their IAS19 pension disclosures and make assumptions about the members of the defined benefit pension schemes they sponsor. The results from these assumptions can have a material effect on the company balance sheet – potentially affecting dividends, credit ratings or banking covenants – so these difficult decisions really matter.
Making an assumption over how long people are going to live now and how that will change in the future is subjective and needs careful judgement. The degree of subjectivity and judgement needed at the 2020 year-end has stepped up because of Covid-19. To complicate matters further, we don’t even know which direction the trend will take us:
Factors potentially increasing life expectancy:
- ”Covid survivors” may have higher average life expectancy than the population before the pandemic.
- Potential stronger resistance to future pandemics or influenza strains, and lower incidence of other infections (e.g. due to enhanced immunity).
- Greater public health focus (e.g. increased NHS investment, better levels of hygiene).
Factors potentially decreasing life expectancy:
- Further direct deaths from the pandemic and potential impairment to survivors through “long Covid”.
- Delays to medical diagnoses and treatments.
- Impact of wider economic recession.
Companies need to weigh up how these and other factors relate to their own circumstances, and then form a view on how current and future life expectancies are impacted. The LCP analysis presented at our annual conference shows a wide range of possible outcomes including:
- improvements in life expectancy “flat line” for the next 10 years (giving a c.2.5% reduction in liabilities for a typical pension scheme)
- improvement rates revert to the levels we saw in the first decade of the century (c.3% increase in liabilities)
- the new factors increasing and decreasing life expectancy broadly offset each other (no change in liabilities)
- the Covid effect is swamped by developments in technology, medicine, lifestyle and the environment (who knows what that means for the liabilities).
The range of outcomes between (1) and (2) above (neither of which are obviously implausible) represents around £100bn for the balance sheets of UK DB pension scheme sponsors.
But what if your scheme members are in a particularly high (or low) socio-economic group? Even then the impact is not clear. Some actuaries and epidemiologists believe that lower socio-economic groups will be more adversely affected based on what’s happened in recent times; on the other hand, others believe the opposite as there’s more “room for improvement” for those groups.
The view I’m mostly seeing so far for IAS19 is that it’s too early to judge either the extent or the direction of these factors, and it is therefore too uncertain to “bank” any significant level of change compared to pre-Covid assumption setting approaches at the current time. If you’re looking for a “middle of the road” accounting approach that’s the place to be. This appears to have been backed up by my experience so far of the auditing community.
My final point though is that the IAS19 assumptions do ultimately belong to the company directors and are meant to reflect their best estimate of the future for their particular scheme members. If you wish to adopt an assumption that results in a material change to liability values, then the rationale will need to be fully considered and explained to various stakeholders including auditors, shareholders and users of the accounts. Of course, like all assumptions, any changes made now may need to be unwound if future evidence emerges to the contrary.