The Institute and Faculty of Actuaries (IFoA) regulates its members to make sure that there is public confidence in its profession.
The IFoA is incorporated by Royal Charter under which it has the role of regulating the actuarial profession, in the public interest.
The IFoA’s Regulatory Policy Statement sets out its approach to that regulatory role.
What this means is that advice given to pension schemes over the implementation and operation of LDI is a regulated activity but not one that the FCA needs to be directly involved with.
IFoA statement on recent gilt market volatility
The IFoA believes that the recent volatility in the gilt markets has not materially impacted the ability of defined benefit pension schemes to meet their obligations to members. The short-term challenge was around operations and liquidity for collateral rather than any risk to members’ pensions. In fact, the rising interest rates mean that many schemes are now better funded and closer to being able to secure benefits with an insurance company.
The Liability Driven Investment (LDI) approach has come under intense scrutiny as a result of recent events. LDI was developed as an attempt to balance long-term obligations to provide pensions with a need to protect short-term funding so that pension trustees can meet their legal obligation to ensure stability of the scheme. Without LDI strategies, schemes would be exposed to the very substantial risk of liabilities increasing much faster than assets in times of falling interest rates, requiring significant additional contributions from sponsors or resulting in members’ benefits potentially having to be cut back in case of sponsor insolvency.
Finding the right balance to manage risk within a pension scheme will always be a challenging task. However, we believe the market turbulence can be a catalyst for open discussion within the industry about whether adjustments or improvements can be made to schemes’ approaches to their risk management and investment strategies, while ensuring public confidence and trust is maintained for consumers. We expect these discussions to be primarily in relation to governance and amount of leverage used rather than necessarily moving away from LDI.
At the IFoA, our Regulatory Board quickly and formally considered whether a Risk Alert on LDIs should be issued, and concluded not at this time although it will continue to keep this question under review. Given its systemic nature, we are also asking the Joint Forum on Actuarial Regulation (JFAR) to consider the subject; the JFAR group comprises many of the regulators who have an interest in or are impacted by recent events in this area.
My answer to the question “Reassurance or fudge?” is: fudge. In particular, note that the IFoA downplays the use of leverage (the main cause of the problems), by mentioning it almost as an afterthought. And in sharp contrast to climate change (for which there has not yet been an actuarial financial crisis) where the IFoA did issue a risk alert, it is odd that the IFoA decided NOT to issue a risk alert on LDI (where there HAS been a financial crisis). (See https://www.linkedin.com/pulse/finally-statement-from-ifoa-its-time-machine-ldi-patrick-john-lee/)
To get an indication of what people think, I suggest holding a poll on this question (Actuarial statement on LDI: reassurance or fudge) e.g. on LinkedIn?
Hello Henry,
As just a member of ‘Joe Public’ I don’t find it very reassurring that the IFoA has passed the subject on. In fact that hints to me there is far more yet to be revealed about LDI that a lot of the participants would not welcome being exposed. I realise this is your Institute but did they (IFoA) issue something similar after 2008? Perhaps they are anxious that they might get caught out in the backwash of any LDI enquiry.
Given that everything at the moment is eclipsed by the Tory Party troubles, this subject is likely to drop from the headlines.
Kind regards,
Tim Simpson
This is actually far worse than a fudge. some quotes and responses below
“LDI was developed as an attempt to balance long-term obligations to provide pensions with a need to protect short-term funding so that pension trustees can meet their legal obligation to ensure stability of the scheme”.
There is no such legal obligation.
“Without LDI strategies, schemes would be exposed to the very substantial risk of liabilities increasing much faster than assets in times of falling interest rates, requiring significant additional contributions from sponsors or resulting in members’ benefits potentially having to be cut back in case of sponsor insolvency.”
It is not liabilities which increase with falling rates, but in fact, the estimated present value of existing liabilities.
“Finding the right balance to manage risk within a pension scheme will always be a challenging task. However, we believe the market turbulence can be a catalyst for open discussion within the industry about whether adjustments or improvements can be made to schemes’ approaches to their risk management and investment strategies, while ensuring public confidence and trust is maintained for consumers. We expect these discussions to be primarily in relation to governance and amount of leverage used rather than necessarily moving away from LDI.”
It is bad enough that LDI strategies involve operations which are illegal, but it is even worse that the IFoA should ignore entirely the externalities, the harm to others of these strategies. But of course, DC savers are far less influential within that body.
What a brilliant example of memo produced by Committee
ie
” ok, I guess we really need to look at LDI because it’s an actuarial thingy that nearly screwed up the whole financial system (and by-the-by led to the removal of sitting PM and CoE), but really let’s not discount LDI because a) our members can actually sell that (as opposed to real investing which is terribly difficult and quite unreliable to us as an income stream), and b) if we assume unlimited collateral and liquidity the model works (so long as one ignores any macro-economic contagion).”