According to Financial Times News, major UK insurers including Legal & General, Phoenix Group, and Pension Insurance Corporation are increasingly using borrowed money to enhance returns on their gilt holdings. These firms are deploying gilt-backed derivative trades like “forward gilt trades” and “par-par asset swaps” that can leverage positions up to three times. The shift comes as the bulk annuity market handles £40bn to £50bn in assets annually, with one adviser suggesting leveraged gilt trades could potentially reach £100bn. The activity has drawn regulatory attention, with the Bank of England monitoring these trades closely and proposing enhanced liquidity-reporting requirements. The moves recall the 2022 gilt market meltdown triggered by Liz Truss’s borrowing plans, though current leverage levels are reportedly lower.
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Deja Vu All Over Again
Here’s the thing that should make everyone nervous: we’ve seen this movie before. The 2022 gilt crisis showed exactly what happens when too much leverage piles into supposedly “safe” government debt. Pension funds got absolutely hammered when they faced collateral calls on their liability-driven investments. Now insurers are essentially doing a version of the same playbook, just with different packaging.
But there are some key differences. Insurers operate under stricter regulatory frameworks than pension funds did back then. They’ve got more collateral options and, according to Phoenix Group’s head of capital markets, “significantly smaller allocations, more collateral, lower leverage.” The leverage ratios today are apparently much lower than the seven-times-plus levels some LDI funds were running in 2022.
Why Now?
So what’s driving this trend? Basically, the math has changed dramatically. Corporate bond yields have collapsed relative to government debt, making those traditional bulk annuity investments less profitable. When you factor in capital requirements, gilts actually look more attractive than credit. And when margins get squeezed, financial engineering tends to follow.
The competition in the bulk annuity market is getting fierce too. We’re seeing major North American private capital groups moving in – Brookfield just bought Just Group for £2.4bn, and Apollo-backed Athora is acquiring Pension Insurance Corporation. When you’re competing against deep-pocketed private equity, the pressure to juice returns is intense.
The Real Winners
One pensions adviser nailed it when he called these trades “boring” and pointed out that “the investment banks have been the real winners, particularly the ones able to package the more levered variations.” I mean, of course the banks are loving this – they’re structuring complex derivatives and collecting fees while insurers take the underlying risk.
The liquidity risks are what keep consultants up at night. As one LCP principal noted, strategies that reshape long-term cash flows need the most care. If markets move against these positions, insurers could face the same collateral calls that crushed pension funds two years ago. Sure, they have more assets to post as collateral, but during a crisis, liquid assets can disappear fast.
Regulatory Watch
What’s fascinating is that some market participants are “somewhat surprised” these trades haven’t been challenged by regulators yet. The Bank of England is clearly aware and monitoring the situation, but they’re taking a measured approach rather than slamming the brakes. That’s probably wise – overreacting could destabilize the very market they’re trying to protect.
Still, you have to wonder: are we just setting up the next liquidity crisis? The financial system has a remarkable ability to forget painful lessons. When everyone’s doing the same “clever” trade, it usually ends badly. The question isn’t if something will go wrong, but when – and how bad the damage will be.
