The Bank of England’s Monetary Policy Committee has turned once again to quantitative easing as the intervention of last resort to try to get the UK economy moving again. The latest announcement was for a further £50bn of asset purchases, on top of the extra £75bn announced last October.
Article from Darren Philp, Director of policy, National Association of Pension Funds
While quantitative easing is considered essential for the wider economy, it is very strong medicine for defined benefit pension schemes that see their funding positions worsen as gilt yields tumble.
Most affected will be those employers sponsoring DB funds that are due to have their triennial scheme valuation this year, and that will be doing so against a backdrop of suppressed gilt yields and inflated liabilities. The latest Pension Protection fund index figures show that the aggregate deficit of DB schemes in the UK has risen to £265.5bn, from an aggregate surplus of £38.5bn just 12 months ago.
What can the government, the bank, or the Pensions Regulator do to help? The National Association of Pension Funds has put forward a number of options that could help DB funds in this difficult position.
At the most radical end, the regulator could suspend triennial valuations altogether until economic conditions improve, and the bank starts to increase interest rates and sell back assets. This is an unlikely scenario.
More reasonably, the government and the regulator could recognise that very low gilt yields, due to a combination of quantitative easing and wider financial market conditions, will inflate DB liabilities where a discount rate is applied that is based on current market information.
Actively encouraging trustees, actuaries and sponsors to apply discount rates that are more reflective of the longer term would be a positive step.
That could be done this April, when the regulator has said it will set out what it expects of schemes currently going through their valuations.
April’s statement could also usefully strengthen the guidance put out in early 2009, which made sponsors aware that scheme valuations could be updated over the 15 months following the valuation date, known as the certification period, to reflect improving market conditions.
However, given the current economic uncertainty, 15 months may not be long enough. The regulator could consider whether it has flexibility to give schemes a longer grace period before their scheme valuation and any resulting recovery plan becomes binding.
The regulator could also be more sympathetic when signing off recovery plans. The average length of plans is currently between 7.8 and 9.4 years and could be extended further.
However, this approach does not address the underlying problem that the deficit being reported is affected by artificially low gilt yields at the time of the valuation.
One further option would be for the bank and the regulator to issue a joint statement about the distortionary impact of quantitative easing on DB funding. The aim of this statement would be to settle the markets.
Corporate sponsors of DB funds are likely to see their market capitalisation suffer when “news” of rising scheme deficits and challenging recovery plans hits the markets and shareholders get nervous about corporate finances.
The bank publicly extending its acknowledgement of the exceptional circumstances facing the UK economy to recognition of the short-term artificial pressures on sponsors of UK DB plans would be a more coherent approach.