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Longevity Risk Transfer: A PPF Perspective Sixth International Longevity Risk and Capital Markets Solutions Conference 9 th & 10 th September 2010. Martin Clarke, PPF Executive Director of Financial Risk.

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martin clarke ppf executive director of financial risk

Longevity Risk Transfer: A PPF PerspectiveSixth International Longevity Risk and Capital Markets Solutions Conference 9th & 10th September 2010

Martin Clarke,

PPF Executive Director of Financial Risk

Pension Protection Fund (PPF) was established in April 2005 to protect members of defined benefit pension schemes
  • PPF pays compensation to members of DB pension schemes where the scheme sponsor becomes insolvent and there are insufficient assets to buy compensation on the open market
    • PPF compensation is 100% of pensions in payment and 90% of pensions in deferment
    • There is a cap in the case of deferred members and indexation/escalation is also capped
  • PPF is funded by:
    • A levy on eligible pension schemes currently £720 million per annum
    • The assets of schemes that it takes over
    • Recoveries from insolvent scheme sponsors
  • PPF is a public corporation established by Act of Parliament but it has no Government guarantee

Vision: Protecting people’s futures.

Mission: Pay the right people the right amount at the right time

its easy to see why we re worried about longevity
Its easy to see why we’re worried about longevity…..

“For a 65 year old male today a 20% improvement in longevity will reduce his annuity by 9%”

Financial adviser

“Demographic picture very worrying – we face a pensioners crisis. Baby boomers reaching age 65 in the next three years – what will they live on?”

Ros Altmann 2009

“I've got all the money I need for my old age... provided I die before 4pm today”

Groucho Marx

“Sharply rising longevity adds urgency to pension review”

Financial Times June 2010

Nobody is disputing the evidence on mortality improvements – people are living longer and this will impact upon pension scheme costs”

The Pensions Regulator 2008

but how do you assess the available options
…but how do you assess the available options?
  • For a traditional carrier, risk is measured as cost of the economic capital required to cover extreme outcomes
    • Hedging solutions such as reinsurance can be judged by the net effect on risk adjusted profit
  • A UK pension scheme it is not required to hold a reserve against uncertain outcomes although its funding has to be based on prudent assumptions
  • Schemes can evaluate the cost of risk as threats to their funding objectives
    • Do they apply risk pricing techniques? Are they looking at all risks or just longevity?
  • There is still room for a qualitative overlay which may come from the sponsor’s overriding desire for stability/predictability

In PPF’s case the position is complicated by its potential to continue to

accrue additional liabilities as a result of future insolvencies

PPF targets “self sufficiency” in 20 years’ time; off-balance sheet risks will then be limited and on balance sheet liabilities mature:

PPF claims as % of PPF liabilities

  • The impact of claims will decline over time
    • Scheme funding will improve
    • Risk mitigation trends continue including buy outs
    • Scheme closures to new entrants / accruals
  • Both UK DB & PPF liabilities will mature over the next 20 years
    • Average age of DB members will increase from 56 to 71
    • 70% of DB liabilities will be pensioner
    • Outstanding duration of PPF liabilities will fall from 21 to 12
  • The population of levy payers will continue to decline
    • Number of levy payers may halve
    • PPF liabilities become 10 to 15% of total DB

Age distribution of PPF members

“Self sufficiency” means that the potential future burden on residual levy payers by 2030 remains affordable
  • PPF investment risk will be reduced to a minimal level
    • Scope to underwrite investment risk positions limited by capacity and appetite of levy payers
  • Residual interest rate and inflation risk will be hedged
    • Dependent on market for available instruments
  • Margin for “unhedgable” risks such as residual claims and longevity
    • Margin initially set at 10% to give a 90% certainty over the remaining period of the fund
    • Balances interests of levy payers and beneficiaries
    • Extreme longevity scenarios likely to prompt a policy reaction
    • But how do we decide to hedge and if so when?

The PPF Board believes that, given future uncertainty and the absence of any

external guarantee, a chance of success of 80% over 20 years is reasonable


A good hedge for PPF is one that improves the funding success rate during the accumulation phase or that reduces the reserve for adverse experience in the decumulation phase

  • Base Case
  • PPF base case has 83% success percentage
  • 1.5% reduction to our funding target improves success rate by 1% (equivalent to a levy reduction of £50m)
  • Diversification effect
  • Over 20 years credit/market risk reduces by two thirds (in economic capital terms from £10 bn to £3bn)
  • Longevity risk rises from 0.8% of liabilities to 7.5%
  • Impact of stochastic vs deterministic mortality in accumulation phase is 1% to success rate

Note that PPF’s appetite for longevity risk transfer will progressively increase

PPF risk composition through time


Market risk


Credit risk

Longevity risk





Decumulation phase

Accumulation phase

Using our funding model we can evaluate the impact of our diversification effect on hedging strategies as shown in this example
  • Let base case assume that PPF will hedge when it becomes self sufficient in 2030
  • We also assume this will be at the current price points we have discovered
  • We can compare alternative strategies that hedge liabilities at an earlier date
  • Breakeven margin is price below which our probability of success improves on base case

Breakeven liability margin vs market prices









*Note that the numbers in this slide have been camouflaged to disguise actual price information in our possession.

The feature illustrated is however based on actual price information


Supported by this analysis we can evaluate different strategies and, in principle, develop a hedging dashboard to reflect our appetite for business

PPF longevity risk dashboard*

  • Basic principle is to seek solutions that improve on our probability of success
  • Although we might eventually have an appetite to hedge, the diversifying effects of other risks suggests we might hold off for a while
  • A wait and see strategy incurs the hazard that market rates may trend adversely

*The ratings in the longevity risk dashboard are for illustration purposes only

This theoretical model is subject to a number of questions and assumptions that must be understood to make any real world decision
  • Base mortality assumptions will differ between the PPF basis and the market
    • Data accuracy; up to date experience investigations; modern factorial analysis; sensitivity tests
  • Diversification benefits may be overstated
    • Sensitivities on key modelling assumptions: ESG calibration, pension scheme risk and behaviours
    • Scenario analysis (in this case a benign economic scenario with few claims and low market volatility)
  • Potential arbitrage of longevity model assumptions and methodology
    • Stress test model and assumptions
  • Robustness of PPF assumption to only fund to a 90% level of confidence on longevity risk
summary and conclusions
Summary and conclusions
  • A financial framework to evaluate hedging options objectively
    • Linked to funding objective and Board’s expressed risk appetite
    • Framework and criteria can be flexed to consider different hedging instruments and segments of portfolio
  • Decisions dependent on market pricing and risk composition
    • How will market pricing and capacity develop in future?
    • PPF is not alone in managing a maturing book of pension liabilities
  • The process is model and assumption dependent
    • The ideal-world solution is perfect knowledge or at least agreed assumptions that strip out any knowledge imbalances
  • Hedging all the risk may not be the best strategy
    • It is possible that market pricing makes some segments of the risk portfolio more attractive to hedge
    • If PPF has effectively hedged the risk above the 90% confidence kevel post 2030, is there more appetite in the market for capped risk?
martin clarke ppf executive director of financial risk12

Longevity Risk Transfer: A PPF PerspectiveSixth International Longevity Risk and Capital Markets Solutions Conference 9th & 10th September 2010

Martin Clarke,

PPF Executive Director of Financial Risk