A picture of health: How are extended lifespans and healthy ageing influencing approaches to UK pensions?

Co-authored

A picture of health: How are extended lifespans and healthy ageing influencing approaches to UK pensions?

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There is increasing evidence that health improvements are leading to longer and more productive lives compared to previous generations. This is a trend that is already having a transformative impact on businesses, pension funds and insurers – offering both new possibilities and challenges to overcome. Our experts from across Lloyds Banking Group examine some topical financial ramifications of our generally increasing healthspan and lifespan.

Minding the gap

Mithesh Varsani,
Head of Investment Solutions,
Chief Investment Office, Lloyds Banking Group

A welcome dilemma

David Adkins,
Chief Investment Officer,
Pensions Investment, Lloyds Banking Group

A domino effect for insurers

Ian Shaw,
Head of Flow Rates,
FI Solutions and Funding Market Sales
Lloyds Corporate & Institutional

Christian De Monte,
Head of Insurance and Group Subsidiaries,
Lloyds Corporate & Institutional

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Mithesh Varsani,
Head of Investment Solutions,
Chief Investment Office,
Lloyds Banking Group

Minding the gap

As people on average live longer in recent decades, having healthy lifetime savings to fund their lifestyle choices is vital. Pensions are typically the largest portion of this, which means that they need to work harder, both in terms of engaging people and encouraging contributions, but also by creatively designing solutions to help maximise pension pots.

Customer-centric propositions are about giving people choice and flexibility. A survey of employees conducted as part of our recent Responsibly Invested Pensions report found, for example, that a third of people wanted flexibility to adjust their pension portfolio based on life changes. This could be options allowing older employees to take their benefits when it suits them, or to partially retire, providing them with greater flexibility and firms with the chance to retain vital skills and experience.

Pensions are evolving to help address the retirement income adequacy gap. Introducing private market assets to broaden the investable universe, investing more in equities, and having a shorter de-risking phase, leaving pension savings invested in higher-growth assets for longer, can all help to maximise growth potential.

And pension providers are also providing solutions to support those living in retirement longer – using to-and-through approaches to maintain market exposure. Diversification also minimises the impact of any market falls as they drawdown. The upcoming Pension Bill calls for the implementation of a default decumulation pathway that pays income.

Technology is enabling and simplifying engagement as part of a holistic approach to lifetime savings and financial empowerment. App-based models allow members to review their pensions, and play around with what different contribution levels, changes to retirement dates, or moving onto different glidepaths, could mean for their future.

The government’s rollout of the pensions dashboards programme will further encourage people to plan for their future. Meanwhile, as an integrated financial provider, we take that a step further, allowing customers to access their entire financial picture through our app.

With pensions in the news, policy evolutions, and the swing from defined benefit to defined contribution schemes picking up pace, the pensions landscape is changing, and our research shows that employees are becoming increasingly pensions aware. It’s more important than ever to work with a pension provider that’s not only developing solutions that match customer behaviour, but can also help you – as an employer – meet the needs of your workforce, and structure your pension fund appropriately.

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David Adkins,
Chief Investment Officer,
Pensions Investment,
Lloyds Banking Group

A welcome dilemma

Over the past decade, UK defined benefit (DB) pension schemes have undergone a dramatic metamorphosis. The combination of rising interest rates, improved funding and better discipline in terms of risk management has eliminated persistent deficits and, in some cases, created healthy surpluses.

For corporates and financial institutions, this has turned the tables. It is now more attractive for firms to shift pension liabilities off their balance sheet, and as a result they are faced with a choice; transfer the risk in its entirety to an insurance firm through a Pension Risk Transfer (PRT) or continue hedging it themselves via a bespoke mix of methods. However, although this conversation is considerably more positive than discussions around pension deficits, it still represents a dilemma for corporates looking to maximise the potential opportunity.

Corporates with small to medium-sized pension schemes are more likely to benefit from transferring financial obligations to the insurance sector via a PRT. By purchasing bulk annuities, the insurance firm not only takes on the investment of the assets and administration of the scheme, but also the risk of people living longer than expected. This has become a preferred path, given that the bulk annuity contract includes built-in hedging for longevity risk alongside other component risks.

It’s estimated that demand for PRT deals is likely to reach £500 billion by 2033.

Some larger firms are choosing to hedge the risks themselves using longevity swap transactions, which ensure that the pension fund retains broader control while passing the risk of extended lifespans on to an insurance firm. This is a time-consuming process and not suitable in every scenario, but longevity swaps can be attractive to firms with large schemes looking to transact in larger sizes. At Lloyds, as a corporate sponsor with a large scheme, this is exactly the route we have chosen. In our case, we have chosen to hedge the sources of material risk using a combination of longevity swap transactions, low-risk asset portfolios, and interest rate and inflation hedging. The hedging of longevity risk should always be tailored to individual requirements. We have a long-term ambition to hedge all of our longevity risk over time.

Longevity has long been seen as an unrewarding risk, and one that is inherently – and perhaps, increasingly – difficult to predict. The transformation of DB pension schemes in recent years, however, has unlocked new possibilities for managing this risk, offering firms effective routes to lock in certainty.

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Ian Shaw,
Head of Flow Rates,
FI Solutions and Funding Market Sales
Lloyds Corporate & Institutional

Christian De Monte,
Head of Insurance and Group Subsidiaries,
Lloyds Corporate & Institutional

A domino effect for insurers

In insurance circles and the wider pension fund industry, understanding the tangible impacts of health improvements and increased longevity is becoming increasingly complex and uncertain. Our close relationships with clients have led to in-depth conversations, exploring the impact of this challenge on firms across the sector and producing some revealing insights.

Notably, trends such as the use of weight-loss drugs and the potential advancement in medical research helped by AI development are making it more difficult to predict the impact on longevity gains. This makes gaining an accurate representation of longevity risk more difficult and prompts insurers to continually review their approaches to managing risk and hedging options.

Longevity swaps have emerged as an important tool for hedging risk over time, yet their universal effectiveness and applicability remain questionable in particular scenarios. While suitable in certain circumstances, the instruments are hindered by intricate modelling requirements, high costs, and a lack of liquidity, making them less attractive for others.

Index-based longevity products have also been considered by some, but the devil is in the detail and these generic approaches often do not achieve their intended purpose due to significant basis risk (the mismatch between the index, and the actual population).

Considering this difficulty, some fund managers are focusing on the assets side. They are choosing to keep riskier assets for a longer timeframe, while also looking for alternative options like private assets with a robust cashflow profile and ideally linked to inflation. A parallel priority is liquidity. Many insurers are reinforcing the liquidity spine that supports their hedging: building collateral waterfalls that go beyond cash, using corporate-bond credit support annexes to cut cash drag, and pre-agreeing repo lines that can be tapped without disturbing strategic positions. This lowers the chance that margin calls translate into asset sales at stressed prices and helps keep risk transfer a choice, not a necessity. In practice, the best results come from treating liquidity as a standing capability rather than a one-off contingency plan. What’s clear, however, is that requirements and risk appetite are not uniform and there is therefore undoubtedly no one-size-fits-all approach.

Specifically in the insurance sector, longevity risk is now a critical component of due diligence in merger and acquisition transactions with management teams actively evaluating both current longevity trends and the potential for future improvements. While longevity concerns are not yet altering the strategic direction of life insurers or their asset-liability management frameworks, differing views on longevity trajectories are creating valuation dispersion. A degree of complacency remains, as many stakeholders expect any material impact from longevity shifts to unfold over the medium-to long-term.

Despite this, longer life expectancy and extended periods of productivity are already reshaping investment behaviour. With a longer investment horizon, some insurers are demonstrating a greater appetite for risk. This shift is also prompting a re-evaluation of product offerings, particularly those designed for the retirement phase.

As people live and work longer, the demand for more flexible, longevity-aware financial products is growing – challenging traditional assumptions about retirement age, income needs and capital drawdown strategies.

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Has your firm made changes to its pension offering in response to gains in overall life expectancy and healthier aging?

Yes – we’ve redesigned products or benefits
In progress – under review or development
No – but we’re considering it
No – not currently a priority

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Key takeaways

Predicting the impact of increased healthspans and lifespans is becoming more complex, making longevity risk management increasingly complex for insurers and pension funds.
Businesses are working closely with pension providers to design and implement solutions that offer more flexibility and reflect employees' changing circumstances.
The transformation of defined benefit pension funding levels in recent years has unlocked new possibilities for firms when it comes to managing balance sheet and longevity risk.
Lloyds can support pension funds and insurers in navigating the impacts of increasing life expectancy, helping to address evolving retirement needs.