Plummeting gilt yields have pushed the UK’s collective defined benefit pensions deficit past the £1trn mark for the first time, pushing up the value of DB transfers and making it more tempting than ever for members to cash in their pensions, consultant Hymans Robertson has revealed.
But the firm warned that succumbing to the “allure of so-called ‘freedom and choice’” under the pension freedoms could have harmful consequences, such as forcing schemes to cut benefits for remaining members.
Hymans Robertson partner Patrick Bloomfield said the latest increase in the DB deficit was a result of the Bank of England’s failure to buy up as many gilts as it had intended, falling short by £52m. This pushed up the price of gilts, and as a result pushed yields down around 0.55 per cent.
“The Bank of England’s reduction in the base rate actually increased demand for gilts, making it less likely that investors will sell to the central bank,” Mr Bloomfield said.
“Every time the Monetary Policy Committee reduces the base rate, it pushes up DB deficits, and that puts even more pressure on trustees to hedge risk. The most impactful way they can do this is through gilt based investments,” he said.
Because DB transfers are calculated according to the cost to a scheme of meeting the member’s liabilities in today’s money, Mr Bloomfield said this meant transfer values were at “record highs”.
However, he cautioned members against succumbing to the “allure” of cashing in their pensions, as low interest rates and yields meant it could be impossible to find a better deal elsewhere without considerably more personal risk.
He also said a rush for the exit could leave remaining members worse off.
“If pension schemes experience a lot of members trying to transfer their pensions out, trustees are likely to use their powers to reduce transfer values to protect their scheme’s funding for those who remain,” Mr Bloomfield said.
For members worried that their DB scheme might be unsustainable, Mr Bloomfield said the key was to find out whether or not they had carried out significant interest rate hedging. Those that had were “generally doing okay”, while those that had not had “been hit very hard over the last few weeks”.
He added the strength of the sponsoring employer was a major factor.
“Pension schemes can weather this storm if they can rely on strong business support. Only members in schemes with less robust sponsoring businesses need to be worried.
“But in the current economic climate it’s unlikely we’ll see a sudden rush of more schemes falling into the Pension Protection Fund. We need to remember that corporate failures in the UK continue to be low, with underperforming businesses propped up by low interest rates and cheap borrowing,” he said.
On Monday the Work and Pensions select committee called for evidence ahead of a major inquiry into the DB sector. The inquiry is expected to look at the possibility of reducing member benefits to prevent more BHS-style failures.
On Thursday, former pensions minister Ros Altman told FTAdviser’s parent paper the Financial Times that the BoE was “not acknowledging the negative impact” its quantitative easing programme was having on pension deficits.
james.fernyhough@ft.com
