Pension funds need more leeway if they are to survive the damaging effects of quantitative easing (QE) and free up billions of pounds for businesses to invest, the National Association of Pension Funds (NAPF) said today.

Schemes want to add a small margin to their discount rate to help them cope with QE, but at the moment they risk being penalised for doing so, warnedthe NAPF. This approach, it said, will "risk harming the wider economy".

The NAPF estimates that lifting discount rates by a relatively cautious 0.5% would reduce the pension fund deficits of FTSE 350 companies going through their funding valuations by 40% to 50%, or over £20bn.

Changing the discount rate would cut pension deficits without putting the savings of pensioners and members at risk. Businesses too would not need to spend as much into filling deficits, and could use it for investment or even job creation instead.

As many funds base their discount rates on gilt yields, which have been heavily skewed by £375bn of QE over the last three years, it has become much more expensive for employers to run defined benefit (DB) or final salary schemes.

With many analysts expecting a further round of QE in the coming months, the NAPF said it is concerned that pension funds will head deeper into the red, and that, despite the Pension Regulator's assurances, businesses will be forced to divert billions of pounds from investment into filling pension holes.

The organisation wants the Chancellor to explicitly acknowledge the issue in his Autumn statement by signalling that a temporary uplift to discount rates based on gilt yields is acceptable, and could be beneficial to the wider economy.

Chairman Mark Hyde Harrison, addressed the matter in his opening speech at the annual NAPF conference in Liverpool, and said: "The current approach to pricing pension funds risks undermining our faltering economy. Businesses are very worried about channelling cash away from jobs and investment and into pension deficits. This could damage the wider economy, which is the opposite of what QE is meant to do.

"We are not against QE, but we are asking for a better way of dealing with its adverse side effects.

"Discount rates are being calculated on artificially depressed gilt yields, and those false foundations are putting a lot of stress on businesses trying to keep a final salary pension going. We cannot predict the next 40 to 50 years on the basis of gilt prices that have been in turmoil for the past three.

"The authorities need to say to those running pension schemes that it's OK for a higher rate to be used, at least until things return to some normality. The Regulator's current approach is – do the sums and then we'll talk about how we can make them work. We're saying let's get the sums right in the first place.

"Letting pension funds raise the discount rate ceiling could make a huge difference – wiping over £20bn off their deficits. It is a relatively straightforward fix and needs no legislative change."

The NAPF thinks the appropriate uplift to the discount rate would be within the range of the Bank's estimates of the impact of QE on gilt yields with some downward adjustments to take account of the offsetting impacts on the asset side.

"Other countries have given pension funds breathing space to adapt to their low gilt environments. It's time we caught up," Harrison told the attendees at the conference.

"We value the current flexibility of the system and recent comments by the Regulator are welcome. However, funds are already hitting the buffers of these flexibilities and risk being penalised by low gilt yields over the next few years simply because they can afford to pay more.

"Creating a temporary uplift to discount rates is a balancing act. It needs to give scheme sponsors enough breathing space while ensuring that scheme members are not placed at risk or left exposed."

The NAPF also wants TPR to be given a new statutory objective to actively support the provision of good pensions.

First published 17.10.2012

azeevalkink@wilmington.co.uk