All entries for Saturday 29 September 2012

September 29, 2012

Effects of QE and low interest rates on pensions worse than SAGA study shows

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Ros Altman (Pensioners billions of pounds out of pocket and Pensioners left £11.5bn worse off by economic policies, Guardian website, 14 September) underestimates the damage done to pensions as a result of low interest rates due to quantitative easing. The report she quotes only looked at money purchase (defined contribution) pensions.

But low interest rates are also playing havoc with defined benefit (mostly final salary) pensions. Although many employers have closed them to new members still about a third of members paying in to these schemes work in the private sector. We usually think of final salary pensions as secure and immune from the vagaries of market forces but that is no longer true.

There is increasing evidence, both from academic research and lived experience, that legislation enacted by the last government aimed at protecting private pensions is in fact having the opposite effect when combined with QE. This situation has led to calls for reform of the way pensions funding levels are calculated, from the National Association of Pension Funds and the CBI.

An unintended consequence of the reforms brought in in 2004 is that very low interest rates like we have now create an artificial deficit for many pension schemes. The reason is technical, to do with the way the liabilities must be evaluated. This makes pension funds appear to be in deficit even though in reality they have enough income to pay the pensions on a sustainable basis.

The legislation requires companies to make extra payments (through a ‘recovery plan’) which many of them cannot afford. So they decide pensions are unaffordable, cut retirement benefits that existing members will receive, and increasingly close the schemes to new members.

The extra payments (estimated last year to be worth £11.6billion for the FTSE100 companies alone) that companies have to make are taking funds away from investment, dividends and wages which not only affects the supply side of the economy but also reduces demand, worsening the recession.

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