The UK has run up a national pension deficit of more than £400 billion ($518 billion) over the past decade, becoming the biggest liability to the economy.
Even worse, the Bank of England’s decision last week to cut interest rates to record lows and begin a bond buying programme of quantitative easing means the deficit is only going to get bigger.
HSBC’s head of European credit strategy Jamie Stuttard warned in a recent note that Governor Mark Carney’s monetary policy move means: “The pension issue is essentially kicked down the road for somebody else to sort out.”
This is not an abstract problem. Although it may be hard to get excited about something that won’t affect you for decades, the solutions to this problem have very real consequences for the country and its people.
Here are just some ways the pension problem might be fixed:
- Retirees take a “haircut” — essentially getting a pension of less than they were promised;
- The government and corporations borrow more to cover the pension shortfall, pushing up national debt levels;
- Companies try and buy-out members of these schemes with so-called “plasma TV deals” that ultimately leave retirees worse off;
- Interest rates finally rise, making investment return target more manageable. But after the first rate cut in 8 years to a new record low, that doesn’t look likely;
- Or the schemes simply collapse in on themselves as we’ve seen with BHS, which sunk under the weight of its own deficit.
The collapse of BHS’ defined benefit scheme has been the most notable example of this type of scheme blowing up but former Pensions Minister Steve Webb says there are “many hundreds of ‘zombie’ schemes” in the UK that have “no realistic chance of the pensions promises being met.”
The below chart from HSBC shows how the UK’s collective pension deficit has transformed from negligible in 2006 to Britain’s biggest liability, eclipsing government and corporate debt:
Even the figure shown above is out of date — the deficit this week hit a record £408 billion, pushed higher by collapsing yields on UK gilts (government debt). 84.4% of UK pension schemes are now in deficit, according to the Financial Times.
What has gone wrong with pension schemes in the last decade? In short, the Bank of England has thrown a major spanner in the works.
Tom Selby, a senior analyst at stockbroker AJ Bell, says: “Savers have unfortunately been caught in the crossfire of the Central Bank’s loose monetary policy over the past decade or so.”
Pensions work like this: you and your employer put money in your pension. The pension provider then invests that money, trying to turn it into enough to cover your retirement. Typically they invest in long-term, stable products like UK gilts (government debt).
But the yield on gilts has collapsed in the wake of the financial crisis, due to demand from other risk-averse investors. The Bank of England’s recently announced quantitative easing programme also doesn’t help. Banks, pension funds, and insurers are unwilling to sell their long-term debt so the BoE has been forced to bid prices higher, hitting yields further. They, in fact, went negative at one point (my colleague Lianna Brinded explored this more here).
The Bank of England’s slashing of interest rates over the last decade also hasn’t helped pensions, as it is hard to find investment products that offer decent returns in a low-interest rate environment.
The below chart from stockbroker AJ Bell shows how yields — the maroon line — and interest rates — the grey line — have collapsed over the last decade as the pension deficit — the black line — has ballooned.
The biggest problem is with defined benefit schemes, which are pension schemes where members are promised a certain level of payout once they retire — £200 a week, say.
These are increasingly unworkable because people are living longer, meaning employers need to meet these payout levels for longer, and because of the investment problem already discussed.
Helen Forrest Hall, defined-benefit policy lead at the Pensions and Lifetime Savings Association, told Bloomberg this week: “We recognise the Bank’s concern and the need to protect the economy but the challenge we have is that the QE programs do have an impact on pension funds’ liabilities.”
A pension scheme forecasts how much it expects to make based on gilts. But if gilts are falling, their expected returns falling, meaning they need to invest more money. That is money they don’t have, meaning deficits rise.
AJ Bell’s Tom Selby says: “Defined benefit sponsors have felt the pain of falling gilt yields, used to price scheme liabilities. While rising longevity, poor governance, and lax regulation all had a part to play — as shown in the BHS disaster — the effect of the Bank of England’s monetary policy has been dramatic, as the chart above shows.”
The worst thing about all this? Credit Suisse says in a note sent to clients on Friday: “In the past couple of weeks both the Japanese and UK authorities launched stimulus packages. Although neither was insubstantial, they weren’t potent or broad enough to shift expectations for growth and inflation.”
“…they weren’t potent or broad enough to shift expectations…”
Mark Carney is digging the UK pensions deeper into a hole in the hope of staving off an economic crash in the short term. But it may not even have an effect. The Bank of England could be fanning the flames of a big economic problem for no reason.
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