BoE bailout

HeyYeah

I’m curious as to what would have happened if the BoE hadn’t began buying guilts this week. Would Some DB pensions have gone bust? What would have happened then? Thanks

mark_cycling00

A similar thing happened at the start of the "financial crisis".

The fed gave billions to 2 banks who had liquidity issues but wouldn't give any to Bear Stearns even though they faced the same liquidity issue.

Bear Stearns had to file for bankruptcy even though it had $50 billion more assets than liabilities. 2 years later every debtor was paid in full by the liquidator.

This signalled to the world that the fed was happy to let random banks fail. And so everything started crashing.

The fed then forced every single bank (even the majority that were still ok) to take a $50billlion loan at a very high interest rate. (Which the us government got a huge profit from)

This signalled to the world that all the banks were in trouble and everything crashed more.

You'd have viable pension schemes going under just because the government refused to listen to advi

arnoldy

What this question re-enforces is that we should not be talking of DBs as one entity. Pensions should at the very least be split into 3:

1. Public sector (Government) DB pensions
2. Private DB pensions
3. Private Defined Contribution (DC) pensions

The difference between private and public DBs is enormous - recent market turmoil has no effect on public (government) DB pensions but has triggered much squeaky bum time about private sector DBs and their funding health. If private DBs go bust mild (at least) poverty awaits as the private DBs schemes go bust & are lowered into the pension protection fund.

biscan25

DB schemes wouldn't have gone bust.
On average DB pension schemes have benefitted from the turmoil, as higher interest rates means the cost of providing benefits in the future goes down.
Many schemes, in particular the larger schemes, have hedged against changes in interest rates using LDI funds. These you leverage to gain a bigger exposure to interest rate matching assets, e.g. gilts.
The problem arises due to this leverage.

Lets say a scheme has £100m assets and £100m liabilities, so is 100% funded.
If a scheme has 40% of its assets in LDI, at a 2.5x hedge ratio, and if the value of gilts drops by 25%, the value of these funds drops by 62.5%, so the scheme loses 25% of its assets overnight. This is fine, you might think, as the cost of the benefits is also reduced by 25%. 
Broadly yes, but:

The LDI fund is now 5x hedged. It needs more capital to get back to 2.5x leverage. In this case it needs £15m, so it asks the scheme for this money. Whether this is a problem, depends on whether the scheme has £15m of liquid assets, e.g. cash or public equity, that it can liquidate immediately to fund the shortfall. If they do, then no problem (except they've had to sell equities when they have gone down a bit, not a serious problem)

The worst case scenario is for schemes which do not hold liquid assets, instead holding things like property or infrastructure.
They are forced into liquidating these at a depressed price (if they can), or reducing the interest rate hedge (in this example to 50%). If they do the latter, the risk is that yields can fall quickly back towards their long term yields, meaning the liabilities go up, but their assets do not cover this change.

Albermarle

The worst case scenario is for schemes which do not hold illiquid assets, instead holding things like property or infrastructure.

Presume you meant to say 'Liquid assets' ?

biscan25

Albermarle said:

The worst case scenario is for schemes which do not hold illiquid assets, instead holding things like property or infrastructure.

Presume you meant to say 'Liquid assets' ?

Yes, edited.

Marcon

HeyYeah said:

I’m curious as to what would have happened if the BoE hadn’t began buying guilts this week. Would Some DB pensions have gone bust? What would have happened then? Thanks

Unfunded public sector pensions don't go bust - they get bailed out by the taxpayer.

Funded public sector pensions don't go bust - they get bailed out by the taxpayer, albeit indirectly (the relevant public sector employers pay more, but that cost is ultimately down to the taxpayer).

Private sector DB pensions look to the sponsoring employer for further funds, assuming the employer is still solvent. If the sponsoring employer fails, and the scheme doesn't have sufficient assets to pay benefits at least as good as those which would be paid if the scheme entered the Pension Protection Fund, then the scheme in question will (after a lengthy assessment period to check eligibility) head for the PPF: https://www.ppf.co.uk

A_T

arnoldy said:

What this question re-enforces is that we should not be talking of DBs as one entity. Pensions should at the very least be split into 3:

1. Public sector (Government) DB pensions
2. Private DB pensions
3. Private Defined Contribution (DC) pensions

The difference between private and public DBs is enormous - recent market turmoil has no effect on public (government) DB pensions but has triggered much squeaky bum time about private sector DBs and their funding health. If private DBs go bust mild (at least) poverty awaits as the private DBs schemes go bust & are lowered into the pension protection fund.

some public sector pensions have no worries at all e.g. NHS and teachers. They don't have any funds and are just paid out of the Treasury like state pension. Others like LGPS, police, university lecturers are potentially vulnerable because they have their own funds.

arnoldy

Of more concern is the annuities market. Investment/insurance companies buy gilts to underwrite the annuities - the prices of gilts have crashed, but the liabilities of these insurance companies on the annuities remains enormous. If I had an annuity I would sweating a bit - both because of the financial health of the insurance company and the effects of inflation eroding its value. As sadly is so often the case the quangos and regulators have been asleep/not sharpest knifes in draw.

Ciprico

Not sure thats the case.  The bonds/gilts that pension companies hold to pay for pensions will be sold at maturity for a fixed/known amount and will have delivered a fixed yield for the entire duration.

Ie totally safe and predicable.. 

The fluctuations during the life of the bond shouldn't be an issue... 

The problem was pension companies were not holding simple bonds. Look at the latest pensioncraft video for full explanation if interested

arnoldy

Ciprico said:

Not sure thats the case.  The bonds/gilts that pension companies hold to pay for pensions will be sold at maturity for a fixed/known amount and will have delivered a fixed yield for the entire duration.

Ie totally safe and predicable.. 

The fluctuations during the life of the bond shouldn't be an issue... 

The problem was pension companies were not holding simple bonds. Look at the latest pensioncraft video for full explanation if interested

Yes, I agree. But I wonder if the Insurance Companies also used the LDI (Liability Driven Investments) to underwrite the annuities. That is, use to Gilts to get leverage to buy other investments but when the Gilts crash the margin calls turn into a self buggering mechanism of forced sales. After all the Insurance Companies that provide the annuities were some of the biggest cheerleaders and providers of these LDIs!!

If private sector DB pension funds merrily used these LDIs to "de-risk" pension payments, why wouldn't private sector Insurance companies use LDIs to "de-risk" annuity payments?

It's all a bit opaque, the sense one gets with the emergency convulsion of BoE is there is a lot of paddling under the water. Maybe more to it?