Personal Pension  

Pensions spotlight - Easing not so pleasing

Having fostered toxic financial assets of devastating economic effects, the US and UK governments are now trying to overcome the paralysis of markets through ‘quantitative easing’ of monetary policy – a euphemism for printing money.

This huge gamble will affect pensioners directly and indirectly. The viability of final salary schemes is made more uncertain. Annuity rates and drawdown limits will fall. Deflation will be replaced by inflation, possibly rampant.

Quantitative easing

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The Governor of the Bank of England has played the interest rate card to its limit, by reducing Bank Rate six times from 5% in September 2008 to 0.5% in February 2009. The Governor obtained the Chancellor’s agreement to use by the Monetary Policy Committee (MPC) of the Asset Purchase Facility to buy £150bn of assets, mostly gilts but including £50bn of private assets like corporate bonds. The Bank authorised the MPC to buy an initial £75bn of assets, predominantly gilts, over three months starting in March 2009.

The ostensible reason for such purchases was to prevent inflation falling below the MPC’s target of 2%, but the bigger reason was to stimulate bank lending and economic activity.

Although the Bank of Japan apparently tried a similar tactic to break stagnation in 2001, quantitative easing is held to be an unproven measure. It assumes that the institutions from whom the gilts will be bought will use their new monies to back extra lending.

But the measure could be ineffective if the banks simply rebuild reserves, or purchase overseas assets instead. Also, pumping such sums into the economy could result in an overshoot, with inflation returning to double digits.

Liabilities rise

Final salary schemes offer much better value than the higher risk/lower contribution money purchase schemes, and it is important for the pensioner population that final salary schemes survive. But, massive purchases of bonds can only drive down the gilt and corporate bond yields that are used under accounting standards to evaluate pension scheme liabilities.

In early March the consultants Hymans Robertson estimated the immediate impact of quantitative easing as a lowering of government and corporate bond yields by 0.3%. The aggregate pension deficit of the FTSE 350 companies under the IAS 19 accounting standard, which uses AA rated corporate bond yields as its reference point, had increased overnight by £12bn, from £43bn to £53bn. Higher deficits can only put more final salary schemes in jeopardy.

Annuity rates fall

The introduction of quantitative easing was followed by a reported reduction of annuity rates by several companies, including Legal & General, Norwich Union, Prudential and Standard Life. Legal and General’s two cuts, amounting to 3%, meant that someone with a £100,000 pot would receive an annuity of £6,920 pa in mid March compared to £7,128 pa two weeks earlier.

The annuity levels for joint lives in suggest that, for a pension pot of £100,000 annuities have ranged over the past five years from a low of about £5,920 in February 2006 to a high of £6,780 in July 2008 – a difference of 14%.

Although quantitative easing did lower the 10 year UK FTSE gilt yield below 3% for the first time ever, the joint life annuity level of £6,140 for 13 March 2009 in Table 1 shows that annuity rates have still to fall below the low of February 2006.