The Bank of England’s intervention in the bond markets on Wednesday has headed off an immediate funding crisis for final salary pension schemes, but has focused people’s fears on how the fallout from the government’s mini-Budget could affect their retirement savings.

Why did the BoE intervene to protect final salary pension schemes?

The bank took action because it feared that the very rapid rise in gilt yields — the interest rate paid on government bonds — in the wake of last week’s mini-Budget could badly damage the financial health of thousands of traditional final salary, or defined benefit, pension plans.

These pensions promise to deliver a secure retirement income based on salary and length of service. To protect them from rising inflation and interest rates, pension managers put in place investment strategies known as hedging.

These strategies are very sensitive to movements in gilt yields which, if not carefully managed, can lead to the pension scheme’s promises exceeding the value of its assets. In normal times, when gilt yields rise schemes may need to sell some of their assets, such as equities and bonds, to help keep their hedging strategies balanced.

However, the unprecedented rate and scale of movements in the gilt markets in recent days left managers scrambling to sell assets to ensure their schemes would be protected.

What did the Bank of England do?

The central bank acted to stop gilt markets from spiralling out of control by suspending its programme to sell gilts — which could drive up yields further — and pledging to buy long-dated bonds.

Citing a “material risk to UK financial stability” the BoE pledged to spend £5bn a day for 13 weekdays, a total of £65bn. UK government bond markets recovered in the wake of the announcement.

“The intervention will help stabilise the gilt market by balancing the numbers of buyers and sellers of these assets,” said Simeon Willis, chief investment officer at XPS Pensions Group.

“In general, investment markets operate better when there is stability. This should mean fewer emergency fire sales of assets by pension schemes.”

How will this affect members of final salary pension schemes?

The good news is that the BoE’s intervention has removed the immediate threat of DB schemes being left unprotected if gilt yields had continued to spiral out of control.

“Pension schemes will now have time to take stock of their financial positions,” said Willis of XPS Pensions Group.

Managing the ongoing risks will no doubt be a problem for companies with DB schemes and their pensions trustees over the coming fortnight, but investment risk is borne by the scheme. Provided the employers sponsoring the pension schemes remain solvent, there is no risk of members’ pensions not being paid in full.

Overall, the funding of final salary schemes has improved this year due to the rise in interest rates, with two-thirds of the UK’s 5,200 DB pension funds now estimated to be in surplus.

“Rising gilt yields are generally good for a scheme’s financial health — but not when the rises are uncontrolled,” added Willis.

How will other types of pensions be affected?

Although the BoE’s intervention was directed at final salary schemes, the rapid repricing of gilts, the weakness in bond and equity markets and the fall in the value of the pound in recent days is hurting investors everywhere.

The majority of UK workers saving into a pension are members of defined contribution (DC) schemes, building up a finite “pot” of money to fund their retirement that can be accessed from the age of 55.

Although members can decide where their money is invested, the default option is typically a blend of equities, bonds, gilts and other assets. Anyone checking their company pension account or self-invested personal pension (Sipp) is likely to see double-digit percentage fall in its value in recent months. This has been compounded by the fallout from the mini-Budget.

This will have less of an effect on younger investors, whose money will be locked up for decades to come, than on older workers approaching retirement, who can flexibly access their funds.

“If you were going to buy an annuity, while the value of your pot will have decreased, rising interest rates means annuity rates have improved [by more than 35 per cent in the past year],” said Sir Steve Webb, former pensions minister and partner at LCP, the consultancy.

“The bigger problem is retirees who were intending to stay invested in the markets, and draw down an income from their pot for the next 20 years. They’ve lost money, and there’s no quick fix,” he added.

In the aftermath of the bank’s intervention, long-term gilt yields fell dramatically, which will provide comfort for investors.

However, separate data from HM Revenue & Customs on Wednesday showed that retail investors were accessing their pension savings in record numbers. In the second quarter of this year, more than half a million people withdrew a total of £3.6bn from their pensions, a 23 per cent year-on-year increase.

“We have never seen more than £3bn accessed [in a single quarter], let alone more than £3.5bn,” said Stephen Lowe, director of Just Group, the retirement specialist. “The underlying worry is that people may be taking a chunk out of their pensions for the first time to tide them through the cost of living crisis, but are unaware of the long-term consequences.”



Source link

By admin

Leave a Reply

Your email address will not be published. Required fields are marked *