Why Pension De-Risking Could Threaten Financial Stability

The IMF has warned of the unknown consequences of pension-risk transfers and the linkages they spawn across financial system sectors.

Transferring pension assets to insurers increases the interconnectedness of the financial system, an International Monetary Fund (IMF) report has warned—and the effects are a long way from being understood.

In a report on the state of the US financial system, the IMF detailed the results of its latest stress tests of banks and insurers. It expressed concern regarding the lack of data available from some firms, meaning the longer-term effects of increasingly large pension-risk transfers on insurers were unknown.

“There are still critical data limitations that the authorities need to address to improve the understanding of interconnectedness.” —IMF“The transfer of pension risk to the insurance industry, through ‘longevity swaps’ and other insurance products, increases the interconnectedness of the system,” the IMF’s report said.

The complex connections across the financial system meant problems in the US housing markets in 2007 rippled through to other entities, eventually leading to the watershed moments of 2008—primarily the collapse of Lehman Brothers and the bailout of AIG.

The authors—the IMF’s Financial Sector Assessment Program—said there were “still critical data limitations that the authorities need to address to improve the understanding of interconnectedness.”

This was in part due to the “fragmentation” of insurance company regulation between state and federal governments, the IMF said, making it difficult to collect accurate data for stress tests.

The IMF cited the Financial Stability Oversight Council’s (FSOC) annual report, published in May, which noted the growing number of counterparties arising from pension-risk transfers “as well as changes in the type and amount of financial counterparty risk”.

“In the case of buyouts, the beneficiaries have their credit exposure shifted from the pension plan to the life insurer,” FSOC said. “Accordingly, the backstop for pension plans switches from the Pension Benefit Guaranty Corporation to the state insurance guaranty funds. In the case of longevity swaps, the counterparty risk is like that of other derivatives and resides with the dealer or insurer.”

The IMF also highlighted underfunded private sector pensions as a potential source of “systemic risk”. The report claimed such funds could find themselves pressured into “undue risk-taking” through strategies such as “direct credit exposure or through securities lending and cash reinvestment”.

Read the IMF’s report: “United States—Financial System Stability Assessment”.

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