The liability-driven investment (LDI) approaches used by some pension managers are expected to be steadily abandoned as rising interest rates make their programs appear to be better funded, enabling the transfer of all the liabilities to insurers.
Steadily rising interest rates and a stabilizing gilt market will set the stage for UK defined-benefit (DB) pension programs to appear better funded. Bloomberg Intelligence expect many companies may seek to pass on these liabilities to insurance companies such as Aviva, Legal & General and Phoenix. The likely limitations would be whether companies have good enough recordkeeping for insurers to undertake the administration and their capacity to assume multiple plans in any given year. As DB programs move away from LDI arrangements as funding improves, that could lead to issues for the gilt market.
Insurers that take on and run fully funded plans might start to broaden the investment portfolio, and as these programs run off over time, the appetite for gilts will naturally fall.
Kevin Ryan, senior industry analyst at Bloomberg Intelligence, said: “A surge in Pension Buyouts Likely in 2023 – Legal & General, Aviva and Phoenix dominate the bulk-purchase annuity market for buy-ins and buyouts in 2021, and when the 2022 numbers emerge, we expect a broadly unchanged situation. In 2023, it's reasonable to anticipate that volume will increase due to defined-benefit plans looking better funded.
“In addition, recent figures indicate a sharp fall in life expectancy between 2021-22; pension programs adopting the 2022 actuarial life-expectancy tables could see a decline in liabilities of as much as 2% – a large move in a single year. The 2022 tables forecast a 65-year-old retiree has a six-months-lower life expectancy, a 1.9% fall, than estimated in 2021.”
Pension Protection Fund monthly data show the UK's 5,215 defined-benefit (DB) programs held £1.5 trillion of assets in October, down from £1.8 trillion a year earlier. Though some of this reflects liabilities dropping to £1.1 trillion from £1.7 trillion as pensions have been paid, we suspect liability-driven investment (LDI) policies will be less popular than before the government's abandoned mini-budget. Those strategies came of age when interest rates fell to zero after the 2008 financial crisis and were essentially a way for pension sponsors to avoid putting more money into the funds. The extreme gilt volatility shortly after the mini-budget outlined on Sept. 23 wasn't expected by sponsors or fund managers. A more conservative or better-funded approach could now emerge. Fund managers in particular would benefit.
Ryan, added: “The gilt market is a thin one with a concentrated ownership structure. The Sept. 23 mini-budget shock involved the government announcing unfunded tax cuts. Those would have eventually required funding by more gilt issuance. That news drove yields to highs. The spike's sharpness is likely due to the fact that the market is just over £2 trillion, of which insurers and pension funds own 27.4%, according to the Treasury's 2022-23 Debt Management Report.”
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