We have just updated www.ukrpi.com, with the statistics and various charts updated until the end of 2023. Just over a year ago, Henry Tapper kindly published our short piece (link below), in which we wondered why ILGs have been so strongly recommended by actuaries and TPR.
Apart from including a short piece on LDI, we have added a little more material about why index-linked gilts seem to have had no real economic purpose. We are not aware of any long-term institutional investor ever demanding index-linked capital. So we have done some simple sums, showing how inefficient ILGs have been at matching income.
Specifically, we have tried fairly pricing a 15 years index-linked (RPI) annuity-certain for years starting between end-1985 and end-2008 (there are 24 periods until end-2023). The price is based upon the initial ILG yield, with no expense or profits allowances made. Allowing for returns and indexed payments of £1,000 pa, if fairly priced, the fund at the end should be zero.
The returns are those on the long ILGs total returns index because the income generated is actually even less important than when they were first issued. Over the 24 periods, the mean experienced RPI increase was 3.10% pa, with standard deviation of 0.41% pa, a minimum of 2.71% pa and a maximum of 3.97% pa. The end-year ILG yields varied between 0.82% pa and 4.49% pa (see chart A below).
As an example, taking the 15 years from end-1985 until end-2000, the initial yield was 3.87% pa, giving an initial price of £11,217. After 15 years, the residual fund is £1,097 which is not what we wanted. To obtain the right outcome, the yield needs to be increased by 0.38% pa to 4.25% pa, giving an amended price of £10,923.
The price reduction of 2.61% for 1985-2000 is somewhat modest, averaging 13.72% over the 24 periods and being as (absolutely) high as 27.61% for 2006-2021. The figures for all periods are tabled (C) and the yields (A) and prices (B) are charted below. On average, over all 24 periods, in order to achieve fair pricing, the initial yield had to be increased by 2.14% from 2.77% to 4.91%, with the price being reduced by 13.72% from £12,202 to £10,467.
This hardly suggests that using ILG yields would have been efficient. Taking these results into account, we can discern even less evidence that ILGs should be taken as systemically important. Why were they so strongly recommended by actuaries and TPR?
Con Keating & Jon Spain 25 Jun 2024
Chart A (Long ILG Yields)
In the chart below, “YieldEst” refers to the original yield, “YieldAct” refers to the required yield and “YieldFix” shows the required adjustment. The table shows the mean, standard deviation, minimum and maximum over the 24 periods.
Chart B (Prices)
In the chart below, “PriceEst” refers to the original price, “PriceAct” refers to the required price and “PriceFix” shows the percentage reduction required, tied to the RHS scale. The table shows the mean, standard deviation, minimum and maximum over the 24 periods.
Table C (Full Results)
