Pension deficits, bond yields and quantitative easing: Why HR professionals need to take note

Blog posts

26 Aug 2016

Stephen BevanStephen Bevan, Head of HR Research Development

At least in the short to medium term, it seems that the Brexit vote may have important consequences for pension fund liabilities. HR professionals who have oversight of defined benefit pension schemes or who are responsible for communicating to employees about pension arrangements may need to monitor these developments over the coming weeks and months. Here’s why.

At the same time as the Bank of England (BoE) reduced interest rates to 0.25 per cent in early August, the Governor Mark Carney, announced a new package of ‘quantitative easing’ measures including the purchase of up to £10bn in corporate bonds. This was intended to stimulate lending to companies at historically low rates, thereby stimulating economic activity and protecting the economy against any Brexit-related uncertainty.

However, as the ratings agency Fitch have recently warned, while the price of these bonds have soared since the BoE announcement, the yields on these bonds have fallen dramatically – with about a quarter now having a negative yield. These yields are the main reference point used by actuaries in calculating defined benefit pension schemes' liabilities - in other words, what they must pay to pensioners during their retirement. In general, the lower the yield, the higher the liability. So as bond yields fall, liabilities increase and widen the gap between these liabilities and the pool of assets that have been paid into the scheme by employees during their working lives.

UK private pensions already have a cumulative funding deficit of £390bn and it has been estimated that the BoE announcement could lead to these widening by a further £30bn. In addition, the value of annuities (the ‘pot’ from which an annual retirement income is paid) fell by 13 per cent after the drop in interest rates. One consequence of all of this is that there will be pressure on employers to ‘top up’ their pension funds from their cash flow, removing cash from other investment opportunities. It is also possible that employees who are approaching retirement may be increasingly concerned that the value of their pension has been hit again. These concerns may be compounded still further if employers continue to adjust the rules of defined benefits schemes for existing members, resulting in increases in contributions or reductions in benefits.

An increase in the BoE base lending rate over the longer term would generally be expected to have the effect of reducing pension fund deficits, and pension fund trustees are expected to take a long-term perspective (ie not to act precipitously) even at this difficult time for pensions. However, the wider uncertainty which is likely to characterise the UK economy in the coming months could mean that HR professionals may need to ensure that they are well briefed on the basics and can ‘signpost’ employees to the right sources of information if difficult or technical questions come their way.

It is clear that an increasing number of employees have financial concerns and that employers are being expected to provide access to information and guidance not just on issues for which they have responsibility – such as pensions – but also financial issues which may affect their wider wellbeing and attendance such as debt, mortgages and rent. IES has previously examined the role of employers in providing financial education for employees and is currently conducting further research on financial wellbeing for the CIPD.

Uncertainty over the implications of Brexit on specific issues such as pensions and on broader topics such as job security are likely to be of concern to employees in certain sectors and at different times over the next few months. HR professionals who are ready with good information and sources of guidance and support will be best placed to help anxious or concerned employees to make informed decisions.

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Any views expressed are those of the author and not necessarily those of the Institute as a whole.