17 October 2012

NAPF: Pension funds need discount rate relief to cope with QE

Funds want to add a small margin to their discount rate to help them cope with QE, but at the moment they risk being penalised for doing so – an approach which the NAPF warns risks harming the wider economy. Changing the discount rate would slash pension deficits without putting the benefits of savers and pensioners at risk. Businesses would not need to put so much cash into filling deficits, and could use it for investment or job creation instead.

The NAPF estimates that even lifting discount rates by a relatively cautious 0.5 per cent would reduce the pension fund deficits of FTSE 350 companies going through their funding valuations by 40 per cent to 50 per cent, or over £20 billion. The discount rate underpins the way that pension funds report their financial health, and is a key factor in their dealings with The Pensions Regulator (TPR). Many funds base their discount rates on gilt yields, which have been heavily skewed by £375 billion of QE over the last three years. This has made it much more expensive for employers to run defined benefit or ‘final salary’ pension funds.

With many analysts expecting a further round of QE in the coming months, the NAPF is concerned that pension funds will head deeper into the red, and that, despite TPR’s assurances, businesses will be forced to divert billions of pounds from investment into filling pension holes The NAPF wants the Chancellor to acknowledge explicitly the issue in his Autumn Statement by signalling that a temporary uplift to discount rates based on gilt yields is acceptable, and could be beneficial to the wider economy.

NAPF Chairman Mark Hyde Harrison said: “The current approach to pricing pension funds risks undermining our faltering economy. Businesses are very worried about channelling cash away from jobs and investment and into pension deficits. This could damage the wider economy, which is the opposite of what QE is meant to do. We are not against QE, but we are asking for a better way of dealing with its adverse side effects. Discount rates are being calculated on artificially depressed gilt yields, and those false foundations are putting a lot of stress on businesses trying to keep a final salary pension going. We cannot predict the next 40 to 50 years on the basis of gilt prices that have been in turmoil for the past three.“

“The authorities need to say to those running pension schemes that it’s OK for a higher rate to be used, at least until things return to some normality. The Regulator’s current approach is – do the sums and then we’ll talk about how we can make them work. We’re saying let’s get the sums right in the first place. Letting pension funds raise the discount rate ceiling could make a huge difference – wiping over £20 billion off their deficits. It is a relatively straightforward fix and needs no legislative change.”

The NAPF thinks the appropriate uplift to the discount rate would be within the range of the Bank’s estimates of the impact of QE on gilt yields with some downward adjustments to take account of the offsetting impacts on the asset side. Individual pension funds use different discount rates.

QE and the UK’s status as a ‘safe haven’ for international investors have forced gilt prices up, reducing the yields that investors make on them. This in turn has pushed discount rates down. When this discount rate is used to calculate the costs of a pension fund for the next 40 to 50 years, it creates a significant increase in the cost.

Even before the £50 billion of additional QE was announced in March, the NAPF estimated that QE had increased pension fund deficits by £90 billion.

Sharp rises in the costs of pension funds are damaging because they mean a business has to put more directly into the fund or set more cash and other assets aside to satisfy The Pensions Regulator (TPR). Yawning deficits can also spook investors by hitting a firm’s credit rating. And a business that is struggling to fund a pension is also more likely to close the pension altogether, meaning staff will lose a valuable benefit.

Mr Hyde Harrison said: “The UK is well behind the curve on this. Other countries have given pension funds breathing space to adapt to their low gilt environments. It’s time we caught up. We value the current flexibility of the system and recent comments by the Regulator are welcome. However, funds are already hitting the buffers of these flexibilities and risk being penalised by low gilt yields over the next few years simply because they can afford to pay more. Creating a temporary uplift to discount rates is a balancing act. It needs to give scheme sponsors enough breathing space while ensuring that scheme members are not placed at risk or left exposed.”

The NAPF also wants TPR to be given a new statutory objective to support actively the provision of good pensions.

Press release

© NAPF - National Association of Pension Funds