UK Parliament – Actuarial News

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The triple lock says that each year the state pension will increase by inflation, average earnings, or 2.5 per cent, whichever was highest in the year before. It is hugely popular with the Conservative party’s elderly base. It is also a fiscal and economic millstone around the British government’s neck.
The last two years have amply illustrated the basic problems with the design of the scheme. The first is that it was clearly not created with unusual economic circumstances in mind. In 2021, wages dropped in a short but deep recession. The next year, they went back up again. In economic terms, very little had changed. The rule used by the triple lock, however, treated this like a period of strong economic growth. If it had been left untouched, pensions would have increased by 8 per cent. And thanks to the ratcheting effect of the triple lock mechanism, they would have retained that boost against UK GDP into the long term.
In the end, the government ended up suspending the triple lock for a year, only to fall right into another unusual situation: stagflation, where economic activity stagnates but inflation skyrockets. Again, the triple lock recommends a large boost to pensions when government finances are already under strain, and again, this would lift up pensions as a share of GDP long term. And again, the government should suspend the rule to avoid this. But it seems Liz Truss has bottled it.
You would have thought it tempting for the Conservative party to wave these away as two unusual years; in normal times – when GDP, inflation, and earnings increase together – then everything would be fine, right? Well, no. The way the triple lock is designed means that whenever you have a downturn, pensions will tend to rise as a share of GDP. And whenever you have a boom, they keep pace. The net effect is a constant ratchet where pensions, in the words of the work and pensions select committee, take up an ‘ever-greater share of national income’.
This is not sustainable. Spending on the state pension is already set to rise significantly as a share of GDP over the coming decades; as the population gets older, there are more people claiming pensions and fewer working to pay for them. Add the triple lock into the mix, and you double the expected increase in demand. Scrapping the arbitrary 2.5 per cent element doesn’t do a lot to help, either; you still have significant growth through the ratcheting effects of the first two elements.

Author(s): Sam Ashworth-Hayes

Publication Date: 19 Oct 2022

Publication Site: The Spectator UK

Bank of England to Treasury, House of Commons

October 10, 2022October 10, 2022 Mary Pat Campbell

Link: https://committees.parliament.uk/publications/30136/documents/174584/default/

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LDI strategies enable DB pension funds to use leverage (i.e. to borrow) to increase their
exposure to long-term gilts, while also holding riskier and higher-yielding assets such as
equities in order to boost their returns. The LDI funds maintain a cushion between the
value of their assets and liabilities, intended to absorb any losses on the gilts. If losses
exceed this cushion, the DB pension fund investor is asked to provide additional funds
to increase it, a process known as rebalancing. This can be a more difficult process for
pooled LDI funds, in part because they manage investment from a large number of small
and medium sized DB pension funds.
Diagram 1 gives a stylised example of how the gilt market dynamics last week could
have affected a DB pension fund that was investing in an LDI fund. In this illustrative and simplified example, the left hand side of the diagram shows that the scheme is underfunded (in deficit) before any change in gilt yields, with the value of its assets lower than
the value of its liabilities. More than 20% of UK DB pension funds were in deficit in August
2022 and more than 40% were a year earlier. In this example, the fund is holding growth
assets to boost returns and has also invested in an LDI fund to increase holdings of longterm gilts, funded by repo borrowing at 2 times leverage (i.e. half of the holding of gilts in
the LDI fund is funded by borrowing). The cushion (labelled ‘capital’) is half the size of
the gilt holdings.
The right hand side of the diagram shows what would happen should gilt yields rise (and
gilt prices fall). The value of the gilts that are held in the LDI fund falls, in this example by
around 30%. This severely erodes the cushion in the LDI fund. If gilt prices fell further, it
would risk eroding the entire cushion, leaving the LDI fund with zero net asset value and
leading to default on the repo borrowing. This would mean the bank counterparty would
take ownership of the gilts. It should be noted that in this example, the DB pension fund
might be better off overall as a result of the increase in gilt yields. This is because the
market value of its equity and shorter-term bond holdings (‘other assets’) would not fall
by as much as the present value of its pension liabilities, as the latter are more sensitive
to long-term market interest rates. The erosion of the cushion of the LDI fund would lead the LDI fund either to sell gilts to reduce its leverage or to ask the DB pension fund
investors to provide additional funds.

In practice, the move in gilt yields last week threatened to exceed the size of the cushion
for many LDI funds, requiring them to either sell gilts into a falling market or to ask DB
pension plan trustees to raise funds to provide more capital.

Author(s): Sir John Cunliffe, Deputy Governor, Financial Stability

Publication Date: 5 Oct 2022

Publication Site: UK Parliament

Bank of England says pension funds were hours from disaster before it intervened

October 7, 2022October 7, 2022 Mary Pat Campbell

Link: https://www.cnbc.com/2022/10/06/bank-of-england-says-pension-funds-were-hours-from-disaster-before-it-intervened.html

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The Bank of England told lawmakers that a number of pension funds were hours from collapse when it decided to intervene in the U.K. long-dated bond market last week.
The central bank’s Financial Policy Committee stepped in after a massive sell-off of U.K. government bonds — known as “gilts” — following the new government’s fiscal policy announcements on Sept. 23.
The emergency measures included a two-week purchase program for long-dated bonds and the delay of the bank’s planned gilt sales, part of its unwinding of Covid pandemic-era stimulus.
The plunge in bond values caused panic in particular for Britain’s £1.5 trillion ($1.69 trillion) in so-called liability-driven investment funds (LDIs). Long-dated gilts account for around two-thirds of LDI holdings.
…..
The 30-year gilt yield fell more than 100 basis points after the bank announced its emergency package on Wednesday Sept. 28, offering markets a much-needed reprieve.
Cunliffe noted that the scale of the moves in gilt yields during this period was “unprecedented,” with two daily increases of more than 35 basis points in 30-year yields.
“Measured over a four day period, the increase in 30 year gilt yields was more than twice as large as the largest move since 2000, which occurred during the ‘dash for cash’ in 2020,” he said.

Author(s): Elliot Smith

Publication Date: 6 Oct 2022

Publication Site: CNBC