UK pension funds and insurers pose risks to financial stability

Bank of England says pension funds and life insurance companies have power to help or hinder UK financial stability

By Szu Ping Chan

Pension funds and life insurers' investment decisions pose a potential threat to UK financial stability, according to research by the Bank of England.

The Bank opened the door on Thursday to a fresh approach to regulating these companies in order to create a more resilient financial system and promote stronger growth.

It said the industry, which looks after £3 trillion of assets in the UK and £30 trillion of assets globally, had "the potential to be a stabilising influence on the financial system" by operating against the business cycle through buying in the dips and selling in the booms. Counter-cyclical behaviour can help to maximise profits for policyholders and aid financial stability.

"[Insurance companies and pension funds] could therefore play a crucial role in supporting both financial stability and long term economic growth," the Bank said in a discussion paper on Thursday.

While the Bank said a lack of data made it difficult to draw conclusions about investment decisions, it said there was "considerable anecdotal evidence" that insurance companies and pension funds tended to adopt a "herd" mentality, where they changed investment strategies at the same time. The Bank said this might contribute to pro-cyclicality, which amplifies booms and busts.

The Bank also highlighted that the industry had reduced its holdings of UK equities largely in favour of bonds over the last 15 years - a process known as "de-risking".

According to the Office for National Statistics, ownership of UK equities by pension funds and insurers in 2012 fell to record lows of 4.7pc and 6.7pc respectively. The Bank said it was important that investors regained their appetite for equities.

"Because equity does a better job than debt of sharing risk between borrowers and lenders, and—because it is perpetual—is better able to support long-term investment projects, this transition away from equity holding by insurance companies and pension funds may leave the system as a whole with poorer risk-sharing and weaker long-term investment."

The research, which was spearheaded by Andy Haldane, the Bank's new chief economist, with input from academics and the industry heavyweights including Jim O’Neill, the former chairman of Goldman Sachs Asset Management and M&G, was designed kick-start the debate within the industry.

While the Bank said more data were needed to draw conclusions about the appropriate policy mix, future options include the introduction of bank-style rules that would require firms to build up capital buffers or commit to reducing pension deficits in times of plenty.

"For both insurers and pension funds, consideration could be given to countercyclical regimes that enable resilience to be built up in benign economic circumstances, in order that regulatory constraints can be safely relaxed in periods of stress," the Bank said. "Such symmetry might help to constrain exuberance in boom periods, as well as providing support in periods of stress," it said.




Source: The Telegraph