While Aviva, Legal & General and peers' revenue may get a shot in the arm as companies rush to offload their pension liabilities amid higher interest rates, the near-universal shift into defined-contribution plans means significantly less natural demand for gilts, according to a new report from Bloomberg Intelligence (BI).
Historically, UK defined-benefit (DB) pension schemes were large holders of UK government securities or gilts. Yet such plans are a thing of the past, believes BI: there are no new schemes being set up, and existing ones are steadily running down as their members enter retirement.
Higher interest rates means the original company sponsors are offloading their pension liabilities to insurers, potentially boosting revenue at Aviva, Legal & General and others. Yet these insurers' exit from the plans makes them net sellers of gilts, notes BI. More importantly, from a government perspective, they aren't buying any more. That risk may spur a new approach to gilt issuance in the coming years, both in terms of tenor and coupon, adds BI.
Kevin Ryan, Senior Insurance Analyst at Bloomberg Intelligence, commented: “If UK pension funds continue to sell gilts at the recent annual rate, they could be out of the bonds in seven years.
“UK pension funds have typically invested in instruments such as gilts and cash to match maturing liabilities as scheme members moved into drawing their pensions. As companies have almost universally shifted to defined-contribution schemes -- and defined-benefit schemes have largely closed to both new members and new contributions -- pension plans have significantly less natural demand for gilts.”
According to BI, insurers and pension schemes now own just 24% of all gilts, from 65% a little over twenty years ago. Between 2020 and the start of 2023, they sold £211 billion of gilts and their overall market share fell 7.8 percentage points.
Bank of England Also a Natural Seller Of Gilts
The Bank of England is a known seller of gilts which, together with the pension-fund exit, could make it tricky for the UK government to raise additional debt, notes BI. The Bank of England began buying gilts in earnest in 2010 and its market share has only risen by about 9pp. Yet the bank's holdings increased 69% between Q1 2010 and Q1 2023, rising to £642 billion from £198 billion.
The quantitative easing that began after the 2008 financial crash was supposed to be followed by quantitative tightening. The gilt crisis of October 2022 -- when selling pressure led to evaporating market liquidity after the mini-budget -- apparently put the bank off and it isn't obvious that much action has been taken since, yet at some stage soon it can be expected to reduce its exposure via QT, adds BI.
Kevin Ryan added: “The UK Office of Budget Responsibility forecasts that in fiscal 2023-24 the government will need to borrow £123.9 billion, followed by £84.6 billion the year after and £76.8 billion in 2025-26. Insurers running DB pension schemes are unlikely to be buyers, given that most of these schemes are closed and running off, paying the members' pensions. Attracting new investors to the UK may present challenges that only high coupons are likely to solve.”
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