The gilt market turmoil that followed the announcement of the mini-Budget caused significant liquidity problems for UK DB schemes. Whilst insurers are also exposed to the same array of risks as DB schemes, we would expect them to be better placed to deal with the recent market turmoil than most pension schemes.

Insurers are generally better funded with more robust and detailed risk management frameworks in place, with investment strategies that focus on holding physical assets that match policyholder cash flows, with less reliance on leverage. Taken together, these factors have helped insurers weather the immediate storm and avoid costly fire sales we are seeing in the pensions industry

Stronger balance sheets with less reliance on leverage

Schemes running leveraged LDI portfolios were hit particularly hard by the recent spike in collateral calls. In contrast to this, insurer balance sheets are stronger and more robust than most DB schemes due to their stringent capital requirements under Solvency II. As a result, insurers don’t need to rely on leverage (in some cases, no leverage) to implement their hedging strategies. Instead, many insurers hedge through holding physical assets held within their Matching Adjustment portfolios.

Higher liquidity buffers

Insurers hold significantly higher liquidity buffers than DB schemes, so they are better placed to meet any collateral calls that do arise. Insurer risk management frameworks actively monitor and stress test liquidity events, with remedial management actions available to be deployed as needed.

Wider pool eligible assets for collateral

The terms for the provision of collateral, including what assets are eligible to be posted as collateral, are set out within a credit support annex (CSA). Whilst most pension schemes are restricted to using cash and gilts, insurers are typically able to negotiate more robust CSAs that include a wider array of eligible assets – including cash, gilts and high-quality corporate bonds (both GBP and non-GBP). As a result, not only do insurers have higher liquidity buffers to meet collateral calls, they also have a wider pool of assets to call upon.

The end result is that insurers are likely to have navigated the recent market turmoil more comfortably than many DB schemes did – collateral calls were met, without the need to sell assets or draw down from borrowing facilities. In addition, increases in gilt yields (over 2022 as a whole) have meant that insurer solvency coverage ratios are substantially higher now than at the start of the year.

What are the challenges down the line?

Notwithstanding this, insurer counterparty risk has increased across the industry. Cost of borrowing is now higher, whilst a bleak economic outlook poses challenges across numerous strands for insurers – from risk of deterioration in credit portfolios to falls in property-backed assets if interest rates remain high. Further implications will arise if the UK sovereign credit rating was to be downgraded in the near-future, having recently been placed on ‘negative watch’.

Schemes looking to undertake buy-in transactions will need to increase their focus on insurer financial strength. Those already holding annuity policies should continue to monitor developments in their insurer counterparty.