Focus on systemic risks after crisis, says ACA chair
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The recent gilts crisis should renew the government and regulators’ focus on systemic risks, the chair of the Association of Consulting Actuaries has said, warning however against “knee-jerk reactions that could introduce new risks to the system”.
Liability-driven investment has been very effective over the past decade and without it, the stresses on defined benefit funding levels, scheme sponsors, and potentially member outcomes during that period could have been severe, said ACA chair Steven Taylor, speaking at an industry dinner this week.
“But, for the industry, recent events have also been a timely reminder that risk management steps must be continually assessed to make sure they stay fit for purpose,” he said. “In that light, I was pleased to see this week’s statement by TPR and other regulators. This aligns well with our calls for increased collateral levels and, importantly, with measures that have already evolved naturally over recent weeks.”
On Thursday, the Pensions Regulator said it would follow the Irish and Luxembourgish regulators in expecting collateral levels to remain at 300-400 basis points, higher than the roughly 200 bps levels seen before the crisis triggered largely by the last government’s ill-fated policy announcements on 23 September.
Taylor said: “For government and regulators, we hope the period will also renew focus on wider systemic risks. DB schemes are among the government’s largest creditor, and so it is no surprise that their combined behaviours can have system-wide effects – especially if prompted by unexpectedly bold policy changes.”
These challenges will need to be managed as schemes mature, he said, “but in doing so it will be vital to avoid knee-jerk reactions that could introduce new risks to the system”.
Taylor gave evidence to the Work and Pensions Committee on 23 November. Another witness, LCP partner Jonathan Camfield, said during the session: “There is a very significant risk of unintended consequences here. As we know within a complex economy, not just pensions, you push down risk in one area, risk can pop up in another area if you are not careful."
DB code under scrutiny over ‘herding’
Taylor said the association was looking forward to contributing to “the next phase of this work”, in particular as further information emerges on the new DB funding code.
Some in the industry have voiced concerns the new funding code will heighten the risks of schemes being affected by gilt yield swings, saying it will push more schemes into the asset class. A second consultation on the DB code is expected this month.
In the evidence session on 23 November, Leah Evans, who chairs the pensions board of the Institute and Faculty of Actuaries, said: “There is certainly a risk of the systemic risk of LDI increasing if there is greater herding of pension schemes towards a very ‘one size fits all’ approach to funding based on gilt yields.”
Evans said “the great strength” of the current funding system is that it is scheme-specific. “It is important for DWP and the Pensions Regulator to reflect on that and the recent experience in the way that they then update funding rules,” she said.
In July, the Department for Work and Pensions consulted on DB funding, laying the groundwork for the code. Under the proposed rules, DB schemes will be expected, once they reach ‘significant maturity’, to invest in matching assets that are “highly resilient to short-term adverse changes in market conditions”, so that no further employer contributions are necessary. Matching assets are typically government bonds.
What do you think – should DB funding rules be redrafted following the gilts crisis?