Pension scheme trustees should strongly consider taking measures to lock in gains amid rising long-term government bond yields and interest rates, according to XPS Pensions Group.

The Bank of England (BoE) increased interest rates by 0.5 percentage points to 1.75 per cent yesterday (4 August), the largest increase in 27 years, in response to soaring inflation.

XPS Pensions Group actuary, Tom Birkin, noted that although the interest rate rise was the largest in a generation, it was largely anticipated by investment markets.

Interest rates have risen by 1.65 per cent in the past eight months, with a similar rise in long-term government bond yields reducing a typical UK defined benefit (DB) scheme’s liabilities by over 20 per cent and a typical scheme's funding levels increased by 12 per cent during that time, according to Birkin.

“Most commentators are expecting rates to rise to above 2 per cent by the end of the year, but with the future far from certain, pension scheme trustees should strongly consider taking measures to lock in some of these gains by reducing levels of risk in their investment strategies or securing members’ benefits with an insurance company,” he added.

LCP partner, Jonathan Camfield, said that whilst much of the interest rate hike was already priced into markets, the further increase in inflation outturn that the BoE is expecting – up to 13 per cent – will be of more immediate interest to pension schemes.

“The longer high inflation continues, and the higher it gets, the more challenging it will be for pension schemes to navigate,” he continued.

“There are significant implications for funding and investment strategies, strategic journey planning, and various aspects of member benefit calculations, all of which should continue to be actively monitored by trustees and employers, to ensure they don’t get wrong footed in this fast evolving situation.”

Hymans Robertson senior investment consultant, Ben Farmer, commented that if the markets believe the interest rate rises currently priced in are insufficient, and inflation continues to increase, there could be further increases in gilt yields.

“Such moves would continue to impact pensions schemes, on both sides of the balance sheet,” he continued.

“Any further rises in gilt yields could see sizeable reductions in liability values. To schemes with lower levels of interest rate hedging this could feed through into material gains in funding level and the potential to lock in funding gains by reducing investment risk, for example by increasing hedging.

“For those with higher levels of hedging and leveraged LDI solutions further rising yields could pose a different challenge, with the need to meet additional capital calls on hedging portfolios. This could either be done by selling non-hedging assets or reducing hedging if there is insufficient liquidity in the scheme.

“With the above in mind, trustees should be speaking to their advisors to determine whether the recent market moves present an opportunity to take more investment risk off the table, protecting their members benefits, or whether your scheme would benefit from a review of its hedging solution. If yield reverse and move lower, this could provide a short-term reprieve from hedging collateral calls, but will ultimately impact funding levels as liability values increase once more.”

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