In a new report (15-page / 3MB PDF), the National Association of Pension Funds said that falling gilt yields as a result of the Bank of England injecting an extra £125bn into the economy had hit final salary schemes "harder than expected". The body has called on the Pensions Regulator to change the way that pension fund liabilities are calculated and to give funds more time to cover deficits.
Last month the Bank of England announced that it would increase the programme by £50bn over the next three months, taking the total investment by the Bank's Monetary Policy Committee (MPC) to £125bn since October - and £325bn overall. It has also held the rate of interest the Bank of England charges other banks to lend money to them at 0.5% since March 2009.
QE allows the Bank of England to inject more money directly into the economy by buying assets from private sector institutions such as insurance companies, pension firms, banks or other companies and crediting the seller's bank account. This means the seller has more money to spend or invest further, while the seller's bank has more money 'on reserve' to lend to other customers. The majority of the extra money has been used to buy government securities, known as gilts, pushing up their prices – which results in the 'yield', or return, on those gilts falling as a percentage of the price.
Final salary and other defined benefit pension schemes, which are schemes that promise a set level of pension once an employee reaches retirement age no matter what happens to the stock market or the value of the pension investment, are particularly affected by QE because they invest heavily in gilts. Lower gilt yields and long-term interest rates affect a formula known as the 'discount rate', which is used by the scheme actuary to calculate the cost of providing all the benefits currently promised during the scheme's regular valuations.
Joanne Segars, chief executive of the NAPF, explained that this "artificial distortion" creates the appearance of a deficit which a pension fund's sponsoring employer is legally obliged to fill.
"That diverts money away from jobs and investment, and will lead to further closures of final salary pension schemes in the private sector," she said. "We need to see stronger action from the authorities on this massive issue, which will hurt pension schemes for some time yet."
She added that although QE made gilts less attractive, the volatility of the stock market meant that employers were still unlikely to move towards riskier investments. In a recent survey of pension funds, only 14% said they would be willing to consider a move away from gilts.
The NAPF called for the Pensions Regulator to use a more stable discount rate, for example one calculated with reference to corporate bond yields, to value pension scheme liabilities as well as extending the 'recovery periods' funds can be given by the regulator to clear their deficits. It has also asked the regulator to issue a joint statement with the Bank of England explaining QE's distorting effect to prevent artificially high pension deficits impacting on company share values.
QE also drives down annuity rates, which are rates at which a pension fund or part of a pension fund can be converted into a regular income under a special policy which can be purchased from an insurance company. According to the NAPF's research, the average person with savings of £26,000 in a defined contribution scheme now gets 22% less income than if they had purchased an annuity four years ago.
The Pensions Regulator plans to issue an annual statement, with the first due in April, to help trustees deal with the valuation and recovery plan process in the current economic climate.
The collective deficit in the of the 6.533 schemes tracked by the Pension Protection Fund (PPF) rose to over £250bn at the end of December 2011 from a surplus of nearly £22m in 2010. The PPF, which is funded by eligible defined benefit pension schemes, pays compensation to pension scheme members if their employers go insolvent and can no longer afford to pay the pensions they promised.