Quantitative easing may be an attempt to stimulate the UK economy, but it does no favours to occupational pension schemes, says Nicola Sullivan
The Bank of England’s move to inject £75 billion into the economy through quantitative easing (QE) has a number of implications for occupational pension schemes. It is predicted that the strategy will increase future price inflation, push up the cost of annuities and increase defined benefit (DB) pension scheme liabilities.
But Sarah Brown, head of the inflation research team and a senior consultant at Punter Southall, said high inflation was not necessarily bad news for employers’ pension schemes.
After it was revealed that the consumer prices index (CPI) measure of inflation had risen to 5.2% and the retail prices index (RPI) had reached 5.6% for September, many members of final salary schemes can expect to see their pensions increase by about 5% next year.
“I know higher inflation will mean higher benefits being paid out because pension increases are linked to inflation,” said Brown. “But pension schemes do have some protection against high inflation because a lot of the benefits have been designed with a 5% cap on pension increases in payment.”
However, the National Association of Pension Funds (NAPF) says QE will make it more expensive for employers to provide pensions and will weaken the funding of schemes as deficits rise. It has called an urgent meeting with The Pensions Regulator (TPR) to discuss ways to protect UK pensions against the negative effects of QE. It wants a number of options to be considered, including extending recovery periods, smoothing valuation results, and postponing valuation dates.
Lindsay Tomlinson, chairman of the NAPF, said: “Pension funds want to see a strong economy, so we understand the thinking behind the latest tranche of quantitative easing, but this is a strong medicine with some nasty side-effects. Quantitative easing is a key ingredient in a recipe that is destroying the value of the UK’s retirement savings. It is a torture for pension funds because it artificially suppresses long-term interest rates.”
QE is also expected to push down gilt yields, which will diminish the value of defined contribution (DC) pension plans and push up the cost of buying an annuity. PricewaterhouseCoopers estimates that a money purchase pension scheme is now worth about 30% less than it was just three years ago.
Mike Smedley, a pensions partner at KPMG, said: “There is a whole range of issues for employees in defined contribution (DC) plans where employers are putting certain amounts of money in, say 10% of pay. When they were putting in 10% of pay five years ago, they might have been saying [to staff] ‘this should buy a pension of around this much’. If they are doing the same projections now, that same money going in is going to be projected by a much lower pension because of annuity rates.
“It is quite hard because, at one level, employers want to be quite transparent and communicate to their staff what they can expect. On the other hand, we have all got our fingers crossed that annuity rates will not be as frighteningly expensive as they look today. Actually, if you are a 40-year-old, does it really matter what annuity rates are today?”
However, employees who are retiring now may find themselves caught between a rock and a hard place. If they defer purchasing an annuity until the market improves, they will either have to carry on working or survive with no retirement income.
And although flexible retirement policies and the removal of the default retirement age give staff more flexibility over when they buy an annuity, in the current economic climate, employers may find it increasingly difficult to move older workers out of the workforce and create openings for fresh talent.
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