Pension plan trustees urged to consider locking in gains amid rising interest rates

XPS Pensions Group says pension trustees should seriously consider taking steps to lock in gains amid rising long-term government bond yields and interest rates.

The Bank of England (BoE) raised interest rates by 0.5 percentage point to 1.75% yesterday (August 4), the biggest increase in 27 years, in response to soaring inflation .

XPS Pensions Group actuary Tom Birkin noted that while the rise in interest rates was the biggest in a generation, it was widely anticipated by investment markets.

Interest rates have risen by 1.65% over the past eight months, with a similar rise in long-term government bond yields reducing the liabilities of a typical UK defined benefit (DB) scheme by more than 20% and typical plan funding levels increased by 12%. percent during that time, according to Birkin.

“Most commentators expect rates to top 2% by the end of the year, but with the future far from certain, pension plan administrators should seriously consider taking action. to lock in some of those gains by reducing risk levels in their investment strategies or securing member benefits with an insurance company,” he added.

LCP partner Jonathan Camfield said that while much of the interest rate hike was already priced into the markets, the further increase in inflation expected by the BoE – up to 13% – will be a more immediate interest in pension schemes.

“The longer high inflation continues, and the higher it increases, the harder it will be for pension plans to navigate it,” he continued.

“There are significant implications for funding and investment strategies, strategic journey planning and various aspects of member benefit calculations, all of which should continue to be actively monitored by administrators and employers, to ensure they are not mistaken in this rapidly changing situation.”

Ben Farmer, senior investment consultant at Hymans Robertson, said if markets believe the currently planned interest rate hikes are insufficient and inflation continues to rise, there could be further increases in bond yields. gilts.

“Such measures would continue to impact pension plans, on both sides of the balance sheet,” he continued.

“Any further rise in gilt yields could result in significant reductions in liability values. For plans with lower interest rate coverage levels, this could result in significant gains in funding level and ability to lock in financing gains by reducing investment risk, for example by increasing hedging.

“For those with higher levels of hedging and leveraged LDI solutions, a further increase in yields could pose a different challenge, with the need to meet additional capital calls on hedging portfolios. This could be done either by selling non-hedging assets or by reducing the hedge if there is insufficient liquidity in the system.

“With the above, trustees should speak to their advisors to determine whether recent market movements present an opportunity to further reduce investment risk, protect their members’ benefits, or whether your plan would benefit from a review of its coverage.the solution.If the yield reverses and declines, this could provide a short-term reprieve from coverage collateral calls, but will ultimately impact funding levels as liability values ​​rise again.