Quantitative Easing Hits U.K. Pension Funds

Terry Flanagan

A U.K. pensions lobby group says that the impact of the Bank of England’s quantitative easing policy, aimed at kickstarting the British economy, has been far worse than expected for pension schemes as falling gilt yields have pushed final salary funds £90bn further into the red.

The National Association of Pension Funds, a UK body which represents 1,200 pension schemes with collective assets of around $800bn, says that the second wave of quantitative easing that started last October, with the ‘printing’—so far— of £125bn in the past six months, is beginning to hurt.

Quantitative easing affects final salary, or defined benefit, schemes because it pushes up the price of government bonds, or gilts, creating lower yields. As pension fund liabilities are calculated using a formula known as the discount rate, lower gilt yields and low long-term interest rates mean pension funds are currently more expensive to fund.

“Businesses running final salary pensions are being clouted by QE,” said Joanne Segars, NAPF’s chief executive. “Deficits that were already big now look even bigger because of its artificial distortions.

“Pension funds want a stronger economy, so they are on board with the QE project for now. But the latest bout of £125bn of money printing has blown a £90bn hole in their side. Firms are legally obliged to fill the deficits, and that diverts money away from jobs and investment, and will lead to further closures of final salary pensions in the private sector.”

The policy of quantitative easing, using electronic money to buy up government bonds, was started by the Bank of England three years ago to help ward off recession. Pension funds are big investors in UK government bonds as the funds need to keep some of their assets in a liquid form and government bond markets represent a highly liquid marketplace in which to invest money, gaining a moderate but risk-free return.

The NAPF is calling on the Pensions Regulator, which enforces rules on schemes, to change the way pension fund liabilities are calculated by giving less weight to gilt yields and give pension funds more time to cover their deficits.

“We need to see stronger action from the authorities on this massive issue, which will hurt pension schemes for some time yet,” said Segars. “And there is always the possibility of QE3.”

In a recent survey of its pension funds, the NAPF found that defined benefit schemes had conflicting views on their future paths. Just 14% of respondents said that they would be willing to consider a move away from gilts and towards higher risk investments, while 16% believed that the current market conditions would, in fact, push them towards gilts and other de-risking strategies. The rest of the respondents were either unlikely to change strategy or had an alternative course of action.

The NAPF estimated that the first round of quantitative easing, which started in March 2009, depressed gilt yields by about 100 basis points and increased pension fund liabilities by around £180bn.

Segars added that savers paying into less generous defined contribution schemes, which rely less on gilt yields, were also being hit. Annuity rates, the rate of return, which are also backed by gilts, were also reduced by up to 22%, said the NAPF chief executive.

“Retirees trying to get a good annuity are feeling the pain too – they are getting a fifth less than they would before QE started,” she said.

Last week, the Bank of England held U.K. interest rates at record lows of 0.5% for a 36th consecutive month. Financial markets currently do not believe that the rate will move upwards until the end of 2013 at the earliest.

Meanwhile, a scheme to allow pension funds the ability to invest in infrastructure projects across the U.K. has been confirmed—potentially offering beleaguered funds an alternative to risk-free gilts.

The pooled fund, which will be up and running from January next year, aims to raise £2bn and give returns of 2%-5% above the retail price index inflation measure.

The platform, backed by the NAPF, the Pension Protection Fund and the Treasury, hopes to get 10-12 pension funds on board before the launch date.

Alan Rubenstein, chairman of the Pension Protection Fund, a statutory fund that provides compensation to members of eligible defined benefit schemes, told the annual NAPF conference in Edinburgh last week: “We see it as a less risky investment than government bonds.”

Although not yet set in stone, the pooled fund would buy the finished projects rather than getting involved in the construction risk. The British government has, however, yet to fully guarantee the project, and take on the risks involved with the construction of projects.

Segars of the NAPF said: “It will be a fund by pension funds for pension funds.”

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