Dynamic Discount Rates: Improving resilience in endgame strategies

In a shifting UK pensions landscape, where trustees are increasingly adopting investment approaches similar to insurance strategies, the method used to value liabilities is gaining significance.

Insurers, under Solvency UK, already use discount rates aligned with their underlying credit portfolios. As pension schemes adopt comparable investment strategies, it is logical for them to consider a similar approach through Dynamic Discount Rates (DDR), as Schroders experts argue in their latest report.

A DDR approach links the discount rate used for funding to the expected return on the assets backing liabilities. This means that funding positions are primarily impacted by fundamental risks, such as credit downgrades and defaults, rather than short-term movements in credit spreads that do not affect cashflows.

Schroders believe this approach offers two key advantages:

• First, it can significantly reduce funding volatility, improving a scheme’s resilience in line with the DB Funding Code.
• Second, it provides greater certainty over the level of surplus that can be generated and potentially extracted over time.

Like this?

IF you’d used DDR, you’d have got the turquoise line and a lot of criticism from the powers that be

More broadly, DDR supports a more representative view of funding by smoothing mark-to-market fluctuations and aligning valuation with long-term investment strategy – an increasingly relevant consideration for schemes pursuing low dependency or run-on objectives.

If you’d had FABI’s means of calculating funding then the asset crash (reckoned by Keating and Clacher of £340bn) would not have happened in the LDI crash at the end of 2022 (the far end of this graph)

Here is the report that Schroders are circulating on Dynamic de-risking.