The rise in gilt yields following Kwasi Kwarteng's "mini-budget" announced on 23 September 2022 led to the Bank of England stepping in to stabilise the market - primarily to protect UK defined benefit (DB) pension schemes from the impact of the volatility which arose immediately afterwards. Here we outline what happened and some of the potential longer-term impact for schemes pursuing liability-driven investment (LDI) strategies.
In order to be able to pay benefits to members as they fall due, DB scheme trustees need to ensure that the scheme has sufficient and appropriate assets to cover these liabilities over the life of the scheme. The funding level of a DB scheme is a broad measure of the extent to which a scheme's assets will be able to meet its liabilities to members at a given point. However, funding levels are susceptible to fluctuations in the value of a scheme's liabilities as a result of adverse changes in interest and inflation rate expectations (and, while outside the scope of this note, the longevity of its members). LDI strategies have formed part of a trustee's toolkit in managing such risks.
It is important to note that each scheme is different and has its own rules, so there is no "one size fits all" approach to managing risk. LDI strategies will depend on factors such as the size and complexity of the scheme. Trustees are also required to take into account the employer’s legal obligation and financial ability to support its DB scheme now and in the future – the "employer covenant" – when setting the scheme's investment strategy.