Pension Deficit Falls

The article above shows the effect that the BoEs Quantitative Easing (QE) policy has had for pension funds. By undertaking QE the yield on government bonds (Guilts) has fallen. This is because the Bank of England purchases Guilts off of financial institutions (banks, insurance firms, pension funds, hedge funds, private investors, equity funds etc) which then go and buy other assets, which may include more Guilts (the reason institutions like buying government debt, despite the yield being so low, is because they are considered very safe, the UK Government currently has an AAA credit rating, and because if necessary it can print money, as it has its own central bank, the risk of it defaulting is considered low). Demand for Guilts rises which causes their price to increase, this results in the yield falling (see this link if you are unsure why) and the government being able to borrow more cheaply. However this also means that the institutions get a lower return on their investments.

This is bad news for pension funds. Pension funds work by employees making a contribution whilst they are in work to a pension fund. This may be topped up or matched by the government or the workers employer. The pension fund then invests this money so that in, say, 30 years time when that worker has retired he has more money for his pension than if he had just put the contributions in a bank account (it should also mean that inflation doesn’t eat away at the value of his money).

However, many of these pension funds are currently in deficit. That is they have promised to pay out more than they can afford. These funds may attract workers to invest in them (give the fund the workers contribution) by offering a certain rate, so they may say if you invest with us for 30 years we will give you X value pension. They then hope that the investments they undertake with the workers contribution will cover this and also make them a profit.

This generally worked well up until the Summer of 2011 when QE began, and the yield of Guilts fell. This meant that pension funds, who owned a lot of Guilts due to their supposedly risk-free nature, were receiving lower returns. This increased their deficit. However recently the size of this deficit has fallen from £252bn in November to £245bn in December. This fall may be attributed to gains in the stock market during that period, as well as dividends being issued in December.

This shows one negative effect of QE and is a good evaluative point to discuss when talking about the Bank of England’s role and Quantitative Easing.

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