Quantitative Easing – a huge mistake

by Dr. Ros Altmann

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The Bank of England has just started implementing its new policy of ‘quantitative easing’. This is a disaster (at least in the short-term) for UK pensions. Since the Bank announced this policy measure, 10 year gilt yields have tumbled. They were already near historic lows and have now fallen even more, thus worsening pension scheme deficits as lower rates push up the value of pension liabilities. For example, the Pension Protection Fund (PPF) has just announced that pension deficits for UK companies to end February had risen by 10% in one month, due to falling asset prices and interest rates, and the further interest rate falls may well lead to even worse deficits as at end March. Unfortunately, end-March is an important pension valuation date, since many schemes will have their triennial valuation calculated as at that date. This will lead to significant problems for employers sponsoring final salary schemes, as trustees will have to demand higher payments. It is likely to hasten the closure of schemes to both new and existing members.

But QE is not just bad news for final salary schemes. Money purchase pension scheme members will also suffer because annuity rates have been worsening substantially too.

The aim of QE is to push interest rates down on both gilts and corporate bonds. But these are the assets which largely determine annuity pricing and the lower yields go, the worse annuity rates get. In fact, the credit crisis had helped annuity rates up to last Summer, because corporate bond yields had risen substantially, but as rates have fallen again, annuity rates have been tumbling. This means people coming up to retirement will really be suffering this year.

People retiring now face a dreadful dilemma. Consider the following example: Someone with £30,000 in their pension fund last year could have retired with a pension of around £2,100 a year for life (using a 7% annuity rate). Someone with £30,000 in their pension fund this year, would only get £1,800 a year (using a 6% annuity rate), this is about 20% less pension for the same money.

However, anyone with £30,000 in their pension fund last year is likely to have far less than that this year, as the markets have plunged. Most funds have lost over a quarter of their value, so the £30,000 fund value last year could be worth only around £22,500 this year. That would now buy an annuity worth just £1,350 a year now – a loss of £750 a year or nearly 35% loss of pension! This year nearly half a million people will buy an annuity and all of them will suffer lower pension income for the rest of their lives as a direct result of artificially depressed interest rates following QE.

Not only this, but I believe that buying gilts is the wrong way to pursue quantitative easing. The aim is to get institutions to switch money from gilts into corporate bonds, but institutions are more likely to switch the money into overseas government bonds, overseas corporate debt or top rated UK company bonds, rather than buying lower-grade corporate bonds issued by smaller and medium sized UK companies who are the ones desperately needing money. Therefore, pensions will be damaged and the policy may not even work!