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What is procyclicality?

In September 2015, the IFoA hosted an expert panel  to explore the causes of, and potential solutions to, a set of connected problems related to procyclicality.

Procyclicality is defined as:

In the short term, the tendency of insurance companies and pension funds to invest in a way that exacerbates market movements and asset price volatility, and, in the long term, the tendency to invest in line with asset price and economic cycles so that the willingness to bear risk diminishes in periods of stress and increases in upturns.The panel concluded that there are systemic issues currently contributing toward a procyclical trend amongst the behaviour of Pension Funds and Life Companies. If left untackled, these could have major implications for consumers, institutional investors and the whole of the financial sector.

Key issues

  • a marked decline in the willingness of pension funds and insurance companies to take on investment risk, with much lower equity holdings in recent years
  • significant herding in the way that UK defined benefit pension schemes have been investing
  • a short term agenda driven by regulation such as the Solvency II framework
  • the need for a better understanding of risk; market risk versus investment risk
  • simpler, more focused institutions that address the structure of the industry and incentives for behaviours

All of these factors threaten the security of retirement income and the availability of finance for investment in industry and infrastructure.

The panel was led by Ashok Gupta, Fellow of the Institute and Faculty of Actuaries and Deputy Chair of the Bank of England Working Group on Procyclicality and Chaired by Stephanie Flanders, former BBC Economics Editor, now Chief Market Strategist for UK and Europe with JP Morgan Asset Management. Other speakers included the economist John Kay, who chaired the 2012 review of UK equity markets, and Alan Rubenstein, Chief Executive of the Pension Protection Fund. 

Watch the IFoA procyclicality Event vox pop

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