Don’t Panic – But it Could be Worse than You Think!!

First the good news is we are being told that the recession is over and the FTSE 100 has risen to over 5300 at at 17th of November. You would think then that pension scheme trustees would be expecting reducing deficits when their scheme actuary comes to look at the figures.

On the other hand, other observers are telling us that pension deficits could have been underestimated by nearly £270 billion, and far from things getting better, in reality the funding position of schemes is getting far worse. And it is beginning to effect not only defined benefit schemes but defined contribution schemes too are also showing severe underperformance.

The reasons for this are complex – isn’t everything in pensions? The Bank of England quantitative easing program has led to a sharp decline in corporate bond yields. Why is this important? Simply because the value of a schemes liabilities are assessed by reference to corporate bond yields. Quantitative easing has released far more corporate bonds on to the market making them cheaper. As the value of these decrease, the size of the liabilities increase. It has acted as a counterbalance to any value that the increase in equity prices may have produced.

There will be no quick fix to the funding problem. Many DB schemes are taking the opportunity to close to future accrual in an attempt to control pension costs. But in a typical scheme, this can take 5 to 10 years to show any significant effect. In the meantime, no government seems able or willing to grapple with the thorny issue of simplification of the pension regime here in the UK. Yet another layer of complexity in the form of Personal Accounts is just around the corner and even were there to be a change of government within the next six months, it is unlikely that any new administration will tear up entirely what is already on the statute book. More’s the pity.