A new study from the Bank of England, led by the bank's Director of Financial Stability, Andrew Haldane and compiled with the expertise of Oxford Martin School academics, examines the risk that the investment activities of UK pension funds and life insurers pose to financial stability and economic growth.
Insurers’ preference for shedding risk in times of volatility may amplify swings in markets and asset prices, the study found. This cuts against their potential to act as a stabilising influence on the financial system by holding assets through the cycle. A preference for fixed-income assets can weigh against the ability of insurers and pension funds to provide the long-term investment needed for economic growth.
Professor Ian Goldin, Director of the Oxford Martin School, is joint Deputy Chair of the group. It also includes Professor John Muellbauer, Deputy Director of Economic Modelling at The Institute for New Economic Thinking at the Oxford Martin School, and Professor Colin Mayer, Peter Moores Professor of Management Studies at Saïd Business School, University of Oxford. Industry participation includes Jim O’Neill, the former chairman of Goldman Sachs Asset Management and M&G, and Peter Davies of Lansdowne Partners.
Releasing the group's discussion paper, the Bank of England said life insurance companies and pension funds (ICPFs) are "important financial intermediaries, which manage the long-term savings of individuals and provide investment to the real economy". In the UK alone, they manage nearly £3 trillion of assets, which is - by some measures - over half of the assets of the UK non-bank financial system. The way in which they manage investments on behalf of individuals is critical, both for those individuals and for the wider economy. ICPFs have the potential both to provide long-term investment to the real economy and to act as a stabilising influence on the financial system, by buying and holding assets across the economic cycle.
However, it is also possible that the combination of factors that drive the asset allocation decisions of ICPFs – market conventions, accounting rules and regulatory requirements – may lead to outcomes that are suboptimal from the perspective of financial stability (through procyclicality) and long-term investment and economic growth (through an unwillingness to bear risk).
The study finds evidence of procyclical investment behaviour by insurance companies. For example, insurers were sellers of equities following the dotcom crash of the early 2000s and to a lesser extent during the recent financial crisis.
In the longer-term, the nature of investments by ICPFs has changed markedly over the past 15 years. Particularly striking has been the decrease in their holdings of equities; the proportion of UK shares owned by UK ICPFs has fallen from over 50% in the early 1990s to just over 10% in 2012. These structural trends are relevant to the willingness of ICPFs to bear risk in the longer term and are potentially significant for the appropriate allocation of capital in the real economy.
The study finds that a combination of factors – in particular the underlying structure of their liabilities, regulation, industry practices, and accounting and valuation methods – influence ICPF behaviour.
The aim of the study is to initiate discussion and add evidence to the debate, as well as to highlight areas for further research which could influence the way that these investments might be managed in future. Although the discussion paper does not present policy conclusions, a clear high-level implication of this work is that policymakers should consider the aggregate impact of regulatory and ICPF industry trends on financial stability and the macroeconomy.