Low interest rates are not just affecting savers – pension funds are feeling the drag too. Defined benefit pension schemes now face the biggest shortfall in history, with a record level deficit of £935 billion.
Like so many falling assets this week, the blame can be laid at the door of Brexit; economic fears have led to investors clamouring for safe havens such as gilts, and the demand has pushed prices high and yields low.
Patrick Bloomfield, partner at Hymans Robertson, said that although rating agencies have downgraded their view of gilts, they are more expensive than ever to buy.
“Regardless of what rating agencies have to say, many investors are willing to pay sky high prices for gilts for the security offered by the British government, even if this is now outside the EU. Some investors are effectively forced into buying gilts because of the way financial regulations work,” he said. “Perversely, higher gilt prices could increase demand for then, pushing gilt prices higher still and potentially sending pension liabilities further north.”
Bloomfield warned that trustees of pension schemes should not be pulled off track by the recent developments and retain a long-term view.
Those running DB schemes need to remember that pensions are long-term and should avoid knee jerk reactions to short term market volatility. The gyrations in UK pension deficits are eye-watering. But one of the biggest factors that will determine whether or not pensions are paid to scheme members in full will be the health of the sponsoring company post Brexit. This should be a primary consideration when making funding decisions for DB schemes,” he said.
“The consensus view is that the short-term economic effects of Thursday’s vote will be predominantly negative. But aggregate figures mask a varied picture. This week companies will be looking at contingency plans and trying to get a handle on what the impact on their business will be, both now and in the long-term. Trustees will rightly want to understand what these plans look like and reassess their scheme funding strategies accordingly.”
What is a Defined Benefit Pension Scheme?
There are currently around seven million people actively saving into defined benefit schemes.
Defined benefit schemes often called “gold-plated” schemes as the retirement income of a scheme member is based on the salary of member and the number of years worked rather than the monetary value of contributions made into a scheme. Almost all employers now offer defined contribution schemes to new employees, which base the member’s retirement income on the amount saved into the scheme over a working life.
Auto-enrolment, the government-led initiative to enrol all workers into a pension, puts savers into defined contribution scheme. Last year, thanks to the auto-enrolment initiative, the number of workers in defined contribution pension schemes surpassed those in defined benefit schemes for the first time. Auto-enrolment will result in around 11 million people being enrolled into DC schemes by 2018.
Today’s Pensioners are Richer than Ever
While those saving for a pension may be worried about hitting their investment goals, those already in retirement are richer than ever according to date from the Office of National Statistics.
In 1994, pensioner incomes were 38% lower than the national average wage. But today, this is just 7%.
Tom McPhail, Head of Retirement Policy for Hargreaves Lansdown says that the increased State Pension and the rise in prevalence of private pensions have both helped to close the gap: "Today's pensioners have worked hard for their prosperity and there are still areas of inequality, both regionally and in terms of age, with older pensioners having lower incomes. Nevertheless, this news is likely to exacerbate intergenerational tensions.”
