The sudden need for pension funds to put up large amounts of extra collateral due to tumbling gilt prices will lead more UK defined-benefit pension funds to favour pension risk transfer deals with life insurers over liability-driven investment (LDI) arrangements with asset managers, Fitch Ratings says.

The rapid drop in gilt prices following the UK’s ‘mini-Budget’ on 23 September led to a sharp increase in collateral requirements from many LDI funds as derivative contracts protecting against lower interest rates moved significantly out of the money. The scale of the extra collateral requirements triggered a sell-off of gilts as pension funds scrambled to find the necessary cash. This exacerbated the fall in gilt prices and led to the Bank of England intervening to stabilise the market.

The crisis highlighted the risks of LDI funds that make substantial use of derivatives, and we believe pension schemes’ appetite for LDI solutions will be greatly reduced as a result. In particular, demand for leveraged LDI structures will have been dealt a severe blow. We also expect pension schemes to be warier of untested non-insurance pension consolidators due to heightened risk aversion.

With LDI funds falling out of favour, Fitch expects pension schemes to become more interested in pension buy-in and buy-out deals with life insurers. Under a buy-in, in return for an upfront premium, the insurer makes payments to the scheme to cover future pension amounts. Under a buy-out, the insurer makes all pension payments directly to scheme members.

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