Yesterday, amid the early morning groan of a hospital ward , I penned a blog on the negative impact of QE and QT on Britain (though I touched on DB pension schemes and DC savers on a “glidepath”), it was inadequate and I am pleased that Pension Oldie has put some meat on the bones.
Please note the comment on this blog, this blog does not deal with the regulatory failure that went with the financial disaster.
Pensions Oldie on the damage to DB pensions by QE
The detrimental effect of QE on pension funds was amplified by a regulatory environment put in place in a non QE environment which continued to be applied when QE was in place:
- A short term market measure (current gilt yield on a specific date) was used as an assumption for the long term future investment return irrespective of the actual investments in the pension scheme. (the long term return of say a 60/40 investment fund has been fairly consistently above 7% p.a. over the past 30 years [except in 2009] but a 2021 technical provision valuation for a DB scheme with a similar liability split between pre-retirement and pensioner liabilities replaced that figure with a 2.8% p.a. assumed future investment return).
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Regulators at the time refused to recognise that their preferred risk measure (based on Gilt yields) for DB schemes had resulted in excessive required risk premiums due to the reduced base return (for example an increase of 0.5% over 20 year gilts resulted in a 35% reduction in required asset values in 2021 whereas it results in a 9.5% reduction in 2025 and represented 11% in 2007).
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Bulk Purchase Annuities were assumed to be the only alternative exit route (other than the PPF) for DB pension schemes unable to run on, without any consideration of the insurance company pricing model. Barriers to entry for possible competitive products were created by legislation and regulation. This gave insurance companies a captive market into which they could charge excessive prices (a 2021 solvency valuation was priced with a 69% premium over the neutral or best estimate valuation, compared with 39% in 2024).
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Employer sponsors of DB pension schemes faced since the late 1990s with falling investment returns, felt after 2004 they were being further penalised by excessive deficit recovery contributions and risk based PPF levies if they continued to guarantee their DB pension liabilities.
This lead to a rather unthinking rush to the exit door of buy-in and buy-out whipped up by the doom laden LDI salesmen using the over priced bulk purchased annuities funeral plan which formed the basis of the regulatory environment as their sales tool.
The unnecessary losses to the individual employers following an LDI Buy-out route in a QE environment have been enormous (£500M in the case of Honda Motors A Pension Scheme Journey Comparison | AgeWage: Making your money work as hard as you do, £500M in Baker Hughes DB Pension Scheme Transaction Transparency and Scrutiny – Baker Hughes (2) | AgeWage: Making your money work as hard as you do, ?£BN for the Nat West Group etc. etc.) and have been obscured by accounting conventions.
This has put British companies at great disadvantage relative to their international competitors and been a major factor behind the lack of growth in the UK economy which more than negated the original purpose of QE.
- In the DC arena, the “pension freedoms” [from annuities] of the 2004 Finance Act had only been introduced shortly before the Global Financial Crisis. However an increasing proportion of Members with DC pots were now in the later stages of lifestyle investment strategies with their emphasis on bonds targeting annuity pricing. Inertia both on the part of the providers and also the Members meant that these investment strategies continued to be followed after QE despite the increased relative cost of bond investments over more “productive” investments. The regulatory and legislative environment was extremely slow in permitting (and may not have even now) the development of alternatives to annuities converting investment pots into retirement income.
Quantitative Easing may have been introduced as an experiment with the laudable aims of avoiding rises in the cost of capital to UK businesses and limiting the loss of tax revenue to interest on increased Government borrowing. However the legislation and regulatory environment surrounding pension provision in the UK have in my opinion completely negated these aims and left the UK economy with lower growth and productivity and a higher tax burden than its peers.
We surely cannot afford to continue to let consideration of risk, especially when entirely hypothetical, dominate aspiration!
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