'Printing money' pushes up pension costs

The Bank’s plan to create up to £150bn in new money by buying £100bn in government bonds and £50bn in private sector ‘toxic’ securities and loans was deemed a success on its first day on 12 March, as banks apparently scrambled to sell paper to the scheme and raise cash.

But it was bad news for defined benefit pension scheme liabilities because, as actuarial firm Hymans Robertson estimates, under accounting standard IAS19 ­ which covers employee benefits and, in particular, pensions ­ the aggregate pension deficit of companies in the FTSE-350 index increased from £41bn to £53bn the night after quantitative easing was launched.

Hymans estimates that the gross redemption yield on the long-dated gilt index, commonly used as a benchmark by pension schemes buying assets to match their liabilities, fell from 4.62% to 4.34%, and that the equivalent yield on AA-rated sterling corporate bonds fell from 6.82% to 6.55%. High-quality sterling corporate bonds are used as a reference point for the calculation of pensions liabilities in company accounts under IAS19.

Hymans’s partner Clive Fortes says the impact of the fall in corporate bond yields will be “significantly detrimental” for companies reporting financial results on 31 March. “Companies reporting on 31 March showing significantly worse pension positions will be, in part, collateral damage of quantitative easing.”

The firm adds that since 31 December last year, the aggregate pension deficit of FTSE-350 companies under

IAS19 has increased by £69bn, moving from a £16bn surplus to a £53bn deficit. This is because of a 20% fall in the value of pension scheme equity assets in that period which, it estimates, accounts for £34bn of the ballooning deficit.

As the price of buying long-dated gilts has been pushed upwards by the government and the Bank buying up around one-third of gilts currently in issue as part of its quantitative easing plan, pension funds and other smaller investors have been “crowded out” of the sale, says Hymans partner Patrick Bloomfield.

Bloomfield also believes pension schemes will suffer if quantitative easing generates inflation in the future.

Since most pension payments have some link to inflation, but funds are not usually permitted to reduce payments in line with deflation, liabilities will remain at an increased level.

“A deflationary spiral would be disastrous for scheme finances,” says Bloomfield. “Quantitative easing measures will be welcomed to the extent that they avert deflation and stimulate a recovery in asset values.”