I’ve been hearing a lot about an argument going on behind the scenes between the Bank of England and the big boy’s regulator the “Prudential Regulatory Authority” and on the other side – the Government – (parliament).
The argument is about who takes the risk of somebody defaulting on a loan. The article below is brilliant and explains it very well , but to understand it, you need to know what a “credit spread” is. If you lend money to the Government at 5% you get a risk free return but if you lend money to a company at 7%, you have a higher but riskier return, the company might not repay you the money and the return you get might be less. The credit spread in this case is 2% or 200bps.
Insurers want to bank returns from riskier lending and the Government supports them. The Government says that the old system (EU Solvency II) stops money flowing to companies and it wants insurers to be incentivised to lend in a riskier way to back up the pensions they pay as “annuities”. The PRA wants to stick with the current system saying that it is the consumer (the pensioner) who will have the risk passed on to them by way of less secure pensions.
But Michael discusses the issue through the eye of someone who is involved in transferring risk from employers to insurers so his views are important.
Yesterday we heard that another £2bn of the liabilities of the British Steel Pension Scheme (the one there’s been so much controversy about) had passed from the responsibility of Tata to Legal & General.
For steelworkers, this is not an arcane academic debate, this is a debate about their future pensions. If that £2bn is going to be supported by lower risk assets – that means they have greater security, if that £2bn is supported by riskier assets, they have less security.
It would seem that the deal with the Trustees (and ultimately with Tata) was cut under the old rules. Will steelworkers benefit if the insurer gets to keep more of the return on the investments that back their pensions – I suspect not.
The Government may want to give a windfall to the insurers but parliament may side with the PRA. Steelworkers might argue that if their pensions are backed by riskier assets , then the upside of taking more risk should be shared through a rise in pension payable.
If this has piqued your interest, you can actually watch Sam Woods delivering the PRA’s position and hear from Andrew Bailey , Colette Bowe and others. Harriet Baldwin chairs what is an argument that impacts everyone who is in a corporate pension or has or will be buying an annuity.
📣 On Monday, we’re holding a session with the Governor of the @bankofengland, Deputy Governor Sam Woods, and external FPC members Jonathan Hall and Dame Colette Bowe on the December 2022 Financial Stability Report.
— Treasury Committee (@CommonsTreasury) January 13, 2023