NATIONAL BUREAU OF ECONOMIC RESEARCH
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New Developments in Long-Term Asset Management

Supported by Norges Bank Investment Management
Monika Piazzesi and Luis Viceira, Organizers
Fourth Annual Conference
Cambridge, MA

May 9-10, 2019

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The Impact of Pensions and Insurance on Global Yield Curves

By Robin Greenwood and Annette Vissing-Jorgensen

While it is well understood that interest rates drive changes in pension funding status, over recent years researchers have uncovered suggestive evidence that the causality may also run in the other direction: pension fund demand may drive interest rates at the long end of the yield curve. We show that these previous findings are part of a much broader global phenomenon of pension and insurance demand driving the long end of the yield curve.

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Our analysis is in two parts. First, we show that countries with larger private pension systems tend to have lower yield spreads on long-maturity bonds, measured as the spread between the yield on 30-year and 10-year government debt. These findings hold despite vast differences in the structure of pension systems around the world — such as recently documented by Scharfstein (2018) — including the proportion of defined-benefit and defined-contribution plans, or whether contributions are voluntary or mandated. We show corresponding results on the impact of the supply of government debt on yield spreads. Namely, countries with a larger supply of government debt tend to have larger 30-10 yield spreads. Supply (measured as debt-to-GDP) and demand (pension and life insurance assets-to-GDP) impact yield spreads with approximately equal magnitude but opposite signs. The most natural interpretation of these findings is that pension funds have a large preferred-habitat allocation to long-maturity bonds (perhaps because of asset-liability matching, and in part driven by regulation) and therefore that countries with large pension assets on average demand more bonds, driving down yields for the longest-maturity bonds.

Second, we conduct a series of event studies to provide better identified evidence that pension and insurance demand causes lower yields on long-term bonds. These event studies also shed additional light on why pension funds demand long-maturity bonds. The event studies are all based on changes in the statutory discount rate by which pensions — and in some cases insurance companies too — value their liabilities for regulatory purposes. Drawing on a series of reforms in northern Europe in recent years, we show that when regulators decrease the P&I sector’s demand for a given asset by changing the regulatory discount curve methodology, this drives up yields and yield spreads. For example, consider the case of the Danish reform in late 2011. As the European sovereign debt crisis intensified, the Danish krone became perceived as a safe haven, and yields on Danish government debt plummeted by 139 basis points over a five-month period. To alleviate the pressure on pensions whose funding position had worsened, the pension regulator announced that pensions and insurance companies would be allowed to increase the rate used to discount long-maturity liabilities, specifically moving the discount rate closer to the yield on euro interest rate swaps than the yield on Danish government bonds. Within two days of the announcement, the Danish 10-year government bond yield had increased by 20 basis points, and 10-year Danish kroner interest rate swap yields by 21 basis points. Overall, the episodes are consistent with pensions demanding the reference asset used to discount their liabilities.

We conclude by discussing the tradeoffs faced by regulators in an era of falling discount rates. In most of the regulatory episodes that we study, the impetus for the change in regulation in the first place was to limit pension funds from feeling forced to buy or sell assets. This activity was ostensibly curtailed by regulators’ announcement of the change in discount curve. While stopping pro-cyclical behavior by pension intermediaries may be useful for avoiding reported solvency, leniency increases the risk that pensions ultimately will not be able to meet their obligations.

 
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