The Pension Investment Academy (PIA) summaries points made by Dr Ros Altmann, SAGA director general, at its seminar last week on the effects of quantitative easing (QE) on pension funds.
At our seminar held in London on 29 January 2013 in conjunction with Westminster Business School, Dr Altmann spoke to the audience of trustees, pensions managers and members of the press of the 'death spiral' of falling gilt yields and de-risking that is enveloping schemes across the UK pensions industry. Dr Altmann argued that this continuing pattern has been caused in large measure by the effects of the Bank of England's decision to implement QE.
Speaking in her personal capacity as an independent pensions expert and former Government pensions policy adviser, Dr Altmann explained that QE's lowering of gilt yields had an instant impact on the deficits of pension schemes, whose liabilities rise significantly as long-term gilt yields fall. This forces schemes to look more actively at de-risking strategies to reduce their deficit – which has historically meant placing more of their assets into what were perceived as 'risk-free' gilts.
However, the Bank of England's decision to buy more than a third of the gilt stock has distorted normal market rates and pushed long yields down further. This then causes schemes to have to look at further de-risking and if they buy more gilts, as the Bank of England also extends its asset purchases, gilt yields keep falling and deficits keep worsening. In addition, trying to 'de-risk' via annuity purchases with buy-ins or buy-outs has also become far more expensive because QE has increased annuity costs. Ultimately, many employers have found that the rising pension deficits and increased cost of de-risking resulting from QE, has forced them into insolvency. Hence the term 'death spiral'.
Dr Altmann advised that a watershed moment has effectively been reached, as the Bank of England's insistence that their QE policy has not damaged pensions has ensured continued pressure on both defined benefit and defined contribution scheme outcomes. Indeed, Dr. Altmann explained that the expected expansionary impacts of QE have also not come to pass. As the UK has an aging population, whose pensions are underpinned by gilt yields, and also as the banking system is impaired and consumers are over-indebted, the normal transmission mechanisms for QE to lead to a rise in lending and spending across the economy have not worked. The Bank's economic models have failed to factor in the 'non-normal' aspects of the UK economy and its analysis has focussed far too much on the beneficiaries of the policy, while failing to carefully consider those losing out.
"QE has hastened the demise of our pensions system," commented Dr Altmann. As scheme deficits rise, their sponsor company's money is being forced into the scheme rather than expanding or modernising the company itself - thereby increasing the risk that the company will fail and the scheme will be forced into the PPF, with all members' pensions reduced.
The PPF's DB deficit figures highlight this impact and also the volatility of the deficit and asset figures that schemes have to cope with. For example - July 2011's PPF deficit figure of £8bn was replaced by £117bn in August 2011, ballooning to £300bn in July 2012 and then falling back down to around £200bn by December 2012. It has therefore become very difficult for trustees to manage the movements of their deficit.
QE has not only damaged DB pension schemes. DC members have also been hard hit, because lower long-term gilt yields mean lower annuity pension income, so those recently or soon to be retired are finding themselves forced to lock into low rates which mean lower pensions for life. Indeed, with annuity rates for a 65 year old man now below 5%, anyone who dies before age 85 will not even receive their full original fund value.
Dr Altmann's view on how to achieve returns was through the use of different asset classes, perhaps overseas, and the diversification of the scheme's sources of return. In addition, infrastructure – particularly if some of the risk and return can be underpinned by the Government or Bank of England – may provide a much needed investment solution for schemes.
With such uncertain economic conditions still causing significant difficulties for many companies, Government policy needs to avoid adding additional unhelpful burdens on employers. Understanding how fiscal and monetary policies affect pensions is increasingly important. In reality, the operation of monetary policy has acted like a tax increase on UK pensions, cutting pension income and forcing firms to divert resources away from growth and job creation. Taxing pension funds and pensioners, when trying to generate an economic expansion would not normally be considered helpful to boosting growth. We are grateful that Dr Altmann was able to provide an opportunity to present explanations to our members who, as was reflected by the concern in the questions that followed in the seminar, will be greatly impacted by the results of QE.
Written by the Pension Investment Academy
