Falling Bond yields, upon which so many pension schemes rely, is particularly problematic for “defined benefit” pension plans, which promise members a specific payout. They use high-grade bond yields to calculate the value of their future liabilities, and every small move downwards deepens their funding challenges. A one percentage point fall in long-term interest rates will increase liabilities of a typical pension scheme by around 20 per cent, but the value of their assets would only go up by about 10 per cent, estimates Ros Altmann, a former UK pensions minister. “Clearly, then, scheme funding will deteriorate and employers will need to increase funding,” she adds.
Faced with a continued subdued outlook for investment returns, fund managers face the unpalatable prospect of inflicting further pain by asking for bigger contributions from pension members and employers, imposing benefit cuts, or closing their schemes.
Baroness Altmann, believes intervention is needed to limit the impact of pension pain spreading to the wider economy, as businesses divert cash from investment into paying more money to plug retirement scheme deficits.
“Government and regulators should be planning to help those pension schemes and their sponsors who may never be able to afford full annuity buyout, without becoming insolvent,” she says. “The development of a regime for ‘winding down’ rather than ‘winding up’, which does not require annuity purchase and which would see pensions paid out of a pooled fund of assets, would be more likely to deliver higher pensions overall.”