The Bank of England is to inject another £50bn into the UK economy in order to restore consumer spending levels and increase corporate lending, but many pension funds will be wringing their hands at the decision 

The new round of asset purchasing by the bank, commonly known in the UK as quantitative easing (QE), was expected given the frail state of the UK economy, but the controversial measure will also bring further unwelcome extra liabilities to pension scheme balance sheets. With bond yields dropping as the bank buys up gilts, the schemes will see their incomes drop considerably compared to their liabilities.

The bank started with QE back in 2009 when expected consumer spending stayed out after the government announced cutbacks as a result of the financial crisis. Initially the bank pumped £200bn into the UK economy, which was followed by another £75bn in October 2011. Now, according to the latest reports, the 'Old Lady' of Threadneedle Street is ready to increase the total investments so that the total figure stands at £325bn.

With the British economy posting an estimated 0.2% contraction in the last three months of 2011 and an uncertain future due to current Eurozone woes, the move was expected by analysts. But some also warn of the effect QE has not only on pension funds and their members, but on the economy itself, which the Bank is trying to help revive.

"More quantitative easing will worsen inflation and lower long-term interest rates, which will worsen pension fund deficits and lower consumer confidence, thus actually damaging, rather than stimulating sustainable growth", warns Ros Altmann, director-general of the Saga Group and a pensions expert.

Altman points out that falling bond yields also make annuities more expensive, giving new retirees much less pension income for their money and leaving them with less spending power.

Mark Gull, the Pension Corporation's co-head of asset management told Pension Funds Insider that QE is a method of "transferring wealth from savers to borrowers". According to the Corporation, a new round of quantitative easing this week could soon add another £85 billion to UK pension deficits by lowering gilt yields by another 30 basis points. Another drop in equity markets (by 10%) after a possible Greek default in March is also factored into this gloomy outlook. 

Speaking to Pension Funds Insider, Shalin Bhagwan, head of structuring in the Liability Driven Investment Funds unit at Legal & General Investment Management, says that QE puts a strain on schemes "when they can least afford it".

"There is a dichotomy going on, cash rich schemes will be fine but others will feel the extra pressure," he says. "Also, is the government really trying to stop schemes from buying bonds and move them to more riskier assets such as equities?"

To the 40% of pension funds in the UK that are due to have their next valuation in March, the move from the Bank of England comes at a particularly important time and many will end up experiencing difficulties, as will their sponsors.

The Pension Corporation previously estimated that pension fund deficits were pushed out by a net £74bn under the first round of QE – the increase in liabilities minus the estimated rise in equities and bonds. "This means sponsors could be forced to pay an additional £7.4bn a year until at least 2020 into their pension fund to cover the additional £74bn hole created by QE1," the Corporation says.

"There will be some companies out there that will need to invest more money in their scheme and consequently can not invest that money elsewhere," Bhagwan says.

The Pensions Corporation sees the same problem and recommends that in the interests of UK pension funds QE2 should not buy gilts with a maturity longer than 25 years and should return to the original mandate - which did not target these long dated bonds which are so popular among pension schemes.

Though QE is said to be a temporary measure, evidence from the Great Depression and Japan's collapse in the late 1990s suggests otherwise, says Gull. He suggests that depressed gilt rates could stay around for "decades, rather than years", directly affecting schemes' balance sheets over that same period.

The latest figures from the PPF 7800 Index show that the aggregate deficit of the 6,533 schemes in the index is estimated to have increased over the last month to £255.2bn at the end of December 2011, from a deficit of £222.1bn at the end of November.

The average funding ratio fell from 81.9% to 80.%, 5,473 schemes found itself to be in deficit and only 1,060 schemes had a surplus.

During the last round of QE Ian Tomlinson, the then chairman of the National Association of Pension Funds (NAPF), already warned that around 1000 UK pension funds were at severe risk of a double hit from "the torture of quantitative easing".

The NAPF claimed at the time that QE would significantly increase the deficits of UK pension funds and that final salary schemes would be forced to close as a result.

So, although strong companies with healthy balance sheets will profit from QE, will the positive effect QE has for them even out the negative effect it has for those schemes, sponsors and retirees who need to be bailed out?

azeevalkink@wilmington.co.uk

First published 09.02.2012