Articles - The Rise of the Pensurance Actuary

 Jay Shah

 By Jay Shah, Partner, Co-Head of Origination and Business Development
 Pension Corporation

 Throughout most of my career, pension actuaries and life-insurance actuaries seemed to be very different breeds. Despite a common actuarial education, their approach to assessing risk and valuing liabilities (sometimes the same liabilities) seemed to be  very different. In fact you would find actuaries working for the same actuarial firm giving different advice depending on whether the client was an insurance company or a pension fund. But this is changing and the change is being led by pension insurance companies that provide bulk annuities to defined benefit pension schemes, such as the company I work for. We employ actuaries from both pension and insurance backgrounds (and indeed a whole range of other experts), to develop insurance based methodologies for valuing pension liabilities. The resulting “discussions” are of course always robust and healthy. In the following, I give just a couple of examples of where thinking is already converging and areas where I hope it will start to meet in the future.

 Longevity expectations
 Arguably the UK actuarial profession has developed some of the most advanced actuarial techniques for measuring current longevity and how it might develop in the future. But only relatively recently have pension schemes adopted (been forced to adopt?) the increasingly onerous future improvement assumptions. In contrast, insurance companies got there many years earlier, where. underlying longevity at a granular member-by-member level is assessed based on socio-economic profiling. Ironically, the “Test Achats” case will mean that insurance actuaries will no longer be able to use one of the strongest predictors of longevity differentials – gender – in pricing retail business. They will surely come up with non-gender alternatives which may well be applicable to pension schemes.

 Discount rates
  How do you determine the discount rate for very long tailed liabilities? Surprisingly, for such a fundamental question, there is little consensus within the actuarial profession. Insurance actuaries, perhaps led by insurance regulation, will take the view that the longer the duration of the liability, the less certainty there is over investment returns, and will adopt prudent discount rates accordingly, perhaps ‘risk free’ rates based on gilt yields. The result is a higher value placed on the liabilities. By contrast, pension actuaries will argue that a long-term time horizon allows a more flexible, higher risk investment strategy leading to higher expected returns and therefore higher discount rates. This leads to a lower value placed on the same liabilities! Nonetheless, we are now starting to see some convergence. As pension schemes close, they mature over time and trustees start to target returns over ever shorter periods (perhaps with one eye ultimately on buying out the liabilities as an end-game). This naturally leads to a more cautious investment strategy and lower (but more certain) investment returns.

 So where might we see more convergence in the future? Both insurance and pension actuaries are starting to adopt a more risk-based framework. The assessment of liabilities (or more correctly the quantum of assets required to meet liabilities) is a function of both the investment returns you expect to earn and the risk that you will undershoot, all neatly captured in the ubiquitous “VaR” (value-at-risk) model. UK regulation for insurers has certainly pushed them down this route. They are required to assess “Individual Capital Adequacy” using a risk based framework and Solvency II will enshrine this approach even more firmly. Equally, as pension schemes close and plan for run-off (bearing in mind run-off is still over several decades), the focus is on matching assets and liabilities as well as the risks that result from a mismatch. One further dimension that pension schemes have to consider is the sponsor’s covenant and the reliance that can be placed on it to fund deficits and mismatches. Again this is a risk-based assessment drawing on techniques developed in the credit rating industry and applying them within an actuarial context.  

 I believe that the convergence of techniques used by actuaries in both pensions and life insurance fields will only continue.  This will be partly due to increasing uniformity being mandated by regulation (in particular I have Solvency II in mind here and its perhaps inevitable future application to pension schemes).  Alternatively both groups will adopt methodologies developed by other professionals in the financial services industry, such as the rating agencies.  Or it may simply be down to actuaries on either side organically sharing best practice  as a result of individuals moving between the fields during their careers or over a particularly sociable drink at a conference.

 Whatever reason though, the dividing line between pensions and insurance actuaries will blur until it becomes more difficult to tell them apart.  These two different breeds of actuaries may even start to talk amongst themselves and their legacy will be a more diversely useful financial professional – the pensurance actuary.

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