Insurers face claims threat from pension fund LDI crisis

The events of the past few weeks are likely to result in claims and/or pressure on commercial relationships, particularly when pension schemes conduct their triennial valuations and agree new deficit reduction plans with employers.

UK pension scheme managers and their insurers could face claims over their use of liability-driven investment strategies following the turbulence caused by Liz Truss's mini-budget

There may be a surge in professional negligence claims against liability-driven investing (LDI) pension funds in the wake of the UK’s mini-budget.

Claims will depend on whether pension funds should have shifted their positions in the months before the mini-budget as interest rates and inflation rose and gilt prices started to fall.

These claims are likely to relate to three time periods: the period leading up to the mini-budget; the period between the mini-budget and October 14, when the Bank of England ceased its bond-buying programme; and the aftermath of this and what actions pension schemes have taken in reviewing their investment strategies.

In relation to the pre-mini-budget period, a professional negligence claim would consider whether LDI was a prudent strategy for the pension scheme, including as part of that question considering whether there was enough liquidity in the fund.

Claims will depend on whether pension funds should have shifted their positions in the months before the mini-budget as interest rates and inflation rose and gilt prices started to fall.

A claim will also hinge on the steps those managing pension schemes took to ensure they reviewed their scheme’s investment strategy and their statement of investment principles. For example: should the pension fund have changed its position when gilt yields started to move higher and interest rates increased in the months before the mini-budget? And how should pension funds have responded to rising inflation, which would influence the interest rate policy of central banks?

If the claim alleges LDI was a negligent strategy, the likely defence would be the strategy was a standard one for the market and fell within what a reasonable manager of a pension scheme’s assets would have undertaken. Investment managers could also argue the mini-budget and the subsequent market response was an unforeseeable event and the losses were so remote any manager of a pension scheme could not be held responsible for these losses.
 
Risk profile

The success of this claim largely depends on the risk profile of the scheme, the investment strategy adopted and whether the strategy mandated by trustees was the one actually adopted. Those managing pension schemes must ensure their asset mix matches their statement of investment principles.

Relating to the period between the mini budget and October 14, a claim is largely dependent on what the scheme’s position was at the time and what options were available based on the scheme’s asset mix. This claim is rather specific and would consider if the right assets were sold to meet collateral calls and to put hedges back in place and if the process was reason¬ably managed given the circumstances.

Finally, relating to the period following October 15, we remain in a period of uncertainty, even after the reversal of the mini-budget. Now is the time for pension funds to review their investment strategy with the scheme’s asset position and funding position in mind.

Steps can be taken to mitigate risk from now on, including reviewing their investment strategy, statement of investment principles and investment mandate, considering the possibility the volatility in gilt yields may return

The events of the past few weeks are likely to result in claims and/or pressure on commercial relationships, particularly when schemes conduct their triennial valuations and agree new deficit reduction plans with employers. This is likely to be a key trend that will develop further in the next year.

This article was originally published in Insurance Day on 2 November 2022.