Regulators and supervisors should act fast to sustain the strength of pension fund and insurance company balance sheets, against a backdrop of sustained low growth and interest rates, the International Monetary Fund said.
In its latest Global Financial Stability Report, published Wednesday, the IMF warned that the solvency of many pension funds and life insurance companies “is threatened by a prolonged period of low interest rates.”
Work by regulators should include identifying and addressing medium-term insolvency risks and funding gaps, and enhancing the “reform agenda for insurers and pension funds by strengthening standards for internal models and capital frameworks,” and improving transparency.
In Europe, the IMF called for strengthened regulation to move toward a common standard for risk assessment of pension funds, and enhanced transparency. “This means valuing assets and liabilities on a market-consistent basis to facilitate standardized reporting and risk analyses, such as stress testing,” the report said. Increased consistency would boost transparency, “including by ensuring regular public disclosure of balance sheet metrics and risk analyses.”
The IMF highlighted that weak growth and low interest rates are increasing the challenges that pension funds and insurers face. It said there has been increased demand for liability-driven investing strategies, which “could substantially increase demand for duration in riskier assets, such as corporate debt and emerging market economy debt, as well as in safe-haven sovereign bonds, particularly U.S. Treasuries.”
However, a bigger shift to these assets will negatively impact yields, “reinforcing funding gaps and thus generating additional demand for bonds in a potentially negative spiral.” Pension fund deficits “may put pressure on the supply of suitable investments,” and a meaningful rise in demand by pension funds “could consume the current outstanding supply, driving corporate spreads much lower and boosting demand for duration in riskier markets,” the IMF warned.
“While lower corporate spreads may support investment and the broader economy, rising exposure to risky assets would increase the vulnerability of portfolios to shocks and higher volatility,” the report said. “The interconnection of pension and insurance companies and their financial systems means that strains in large or medium-size entities could quickly spread, underscoring the need for prompt regulatory enhancements to ensure their health.”
The report is available on the IMF's website.