QE and pension schemes
The Bank of England’s decision to extend quantitative easing by £50 billion (taking the total value of the QE programme to £325 billion) is welcome, providing further stimulus to our stagnating economy. Particularly in the absence of any significant Government stimulus measures, using monetary policy to prevent a second credit crunch and keep long-term borrowing costs low, therefore boosting activity in the rest of the economy, is currently one of the most significant interventions available to support us back to growth.
But QE is far from perfect as a means to support the recovery, with increasing evidence that bank lending remains depressed despite the additional balance sheet boost that QE is providing. This has led many, including Monetary Policy Member Dr Adam Posen, to call for a new type of QE to be developed, which would involve the Bank of England providing direct support to small and medium sized businesses, rather than, as is currently the case, buying Government bonds directly from banks and large financial institutions. And, with no economists entirely sure what the effects of the intervention are, there is also increasing evidence that while QE has boosted confidence and growth it may in the process have pushed up inflation (by boosting demand for assets which would not otherwise have been so highly priced) which would affect those who are already the poorest the most.
Consequently, QE has potential impacts on members of both defined contribution (DC) and defined benefit (DB) pension schemes. For defined benefit schemes, low gilt yields will result in larger pension scheme deficits.. It could also result in employers having to spend more money on their pension scheme than planned, diverting money from other aspects of their business including job expansion and investment. In a worst case scenario, low returns on investments could result in a reduction in pension scheme benefits or even closure of DB schemes. For defined contribution schemes, QE could also raise annuity rates resulting in a lower pension for scheme members. Members having to buy annuities at this time will not be able to change their annuity at a later stage should annuity rates improve.
The announcement of the third round of quantitative easing follows the findings of the Mercer Pension Risk Survey which showed that the combined DB scheme deficit for FTSE 350 companies at 31 January already stood at £83 billion (calculated on a 85 per cent scheme funded ratio basis). By way of comparison, the Pension Protection Fund / Pension Regulator’s latest Purple Book recently published shows that the total deficit on an estimated full buy-out basis for all DB schemes in deficit stood at £470.7 billion as at 31 March 2011. And the Pension Protection Fund’s latest 7800 Index which covers 6,432 DB schemes estimated that the aggregate deficit of all schemes in deficit (5,388) at the end of January 2012 was £289.9 billion measured on a section 179 basis (ie. the premium that would have to be paid to an insurance company to take on the payment of PPF levels of compensation).
But, despite these increasingly well documented downsides, the reality remains that it simply isn’t in the interest of pension funds or pensioners for the economy to shrink, which would substantially increase downward pressures on fund values, on employers’ capacity to keep schemes open and on the living standards of today’s and future pensioners. While rising gilt yields might superficially be good for pension funds in a stagnating economy they would also risk significant negative impacts on the cost of borrowing and on our wider economic health. So, particularly given the lack of an alternative government strategy to boost demand, QE may be a necessary, but not pain free measure to support growth. The real worry is that on its own, it’s unlikely to be enough – we can only hope the Chancellor takes the opportunity of his forthcoming Budget statement to change the Government’s wider economic course.