'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.”