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I was recently speaking to someone who works at a UK life insurer which offers defined benefit pension scheme buy-outs. He mentioned that the company employs traders (of bonds and swaps, mostly) and has a hedging team who prescribes limits to the traders on a weekly basis.

He explained that the hedging team consider metrics such as PV01 and IE01 and report on the resulting change in the value of future asset cash flows and future liability cashflows in order to come up with these trading limits.

I am currently working at another life insurer (my first job since university) and everything that he has describes sounds very alien to me. We too invest in bonds and swaps to ensure that we are able to meet our future obligations, but the cashflows are matched relatively closely and (to my knowledge) the hedges that we have in place are static: we might buy some inflation swaps to hedge the exposure on our index-linked annuity business, but once set up there is no further management required on this hedge.

He did mention that when a client comes to them with several billion pounds to take on their pension liabilities, they cannot immediately go away and use this money to buy assets that perfectly match the liabilities of the scheme; it takes a lot of time to invest such a large amount of capital. Thus, they have funds that are set up in anticipation of new business being written, and also invest retrospectively to meet the continuing liability payments associated with the existing business.

Still, I am left wondering why they have traders and a hedging team who are so reactive to market changes and who monitor/alter the position of their investments on a continuous basis?

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  • $\begingroup$ Is it possible there are some embedded options in the liabilities ? Eg minimum rate guarantees etc? Those would require frequent rebalancing. $\endgroup$
    – dm63
    Jun 8 '20 at 2:37
  • $\begingroup$ Some liabilities would be inflation linked (with caps and floors), but couldn't this be statically hedges using inflation swaps/futures? $\endgroup$
    – John Smith
    Jun 8 '20 at 6:14

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