Bank of England’s QE Hit Underfunded Pensions Badly

While adequately funded pension plans fared fine, underfunded plans were left worse off by the Bank of England’s quantitative easing.


Quantitative easing (QE) has increased the size of deficits for many of the U.K. defined benefit schemes already suffering substantial shortfalls when the program began in 2009, the Bank of England has acknowledged.

Its admission that a central bank program has hit some pension funds increases the onus on the U.K. government, including its pensions regulators, to ease the short-term pressure on schemes to make up their deficits — though it is unlikely to make any difference to the pressure exerted in the longer term.

However, the average scheme that was fully funded at the outset of QE has not been hit by it, the Bank concluded, in a report looking at the effect of QE on income and wealth published on Thursday in response to complaints by politicians and the pensions industry about the alleged damage wreaked by the program.

QE has made life harder for defined benefit scheme trustees because the discount rate used to calculate the net present value of the schemes’ liabilities is based on the yields of long-term U.K. government bonds, or gilts. These have been pushed down by large-scale purchases under the QE program, since a lower discount rate generates a higher value. The Pension Protection Fund, a regulator that monitors deficits, has calculated that a 0.1 percentage point fall in gilt yields raises liabilities by 2 percent. The yield on benchmark 10-year gilts was 1.52 percent at the close of Friday trading, compared with a rate of 3.63 percent on the eve of QE in March 2009.

However, the Bank’s report declares that QE also increased the value of pension fund assets.

“If a pension fund is fully funded and holds government debt with coupon payments that exactly match the future flow of its liabilities, then a change in gilt yields would have no net impact,” says the report. Moreover, even a fully funded pension fund with a mix of gilt and equities “would not have been materially affected by QE,” because “estimates by the Bank suggest that QE increased the value of equities by a broadly similar amount to gilts.”


However, the Bank acknowledges problems for many schemes that were not fully funded when the largely successful QE process began.

“For a defined benefit pension scheme in substantial deficit, asset purchases are likely to have increased the size of the deficit,” said the report. “That is because although QE raised the value of the assets and liabilities by a similar proportion, that nonetheless implies a widening in the gap between the two.”

The Bank did not offer precise estimates of how much QE increased liabilities and assets.

However, to use an example based on the Bank’s logic that the increases in liabilities and assets were proportionately similar to each other; a pension scheme with £100 million ($158 million) in liabilities and £90 million in assets in March 2009 would have had a deficit of £10 million. Assuming a 10 percent rise in both assets and liabilities because of QE, by now the scheme would have £110 million in liabilities and £99 million in assets — increasing the deficit to £11 million.

The FTSE 100 stock index has risen by 58 percent since QE began, to close at 5,777 at the end of last week’s trading (Friday, August 24). Analysts credit QE for playing an important role in this rebound by preventing the U.K. economy from spiraling rapidly downwards. Nevertheless, the FTSE 100 is still below its 2007 peak, with investors reluctant to bid equity prices aggressively upwards given the U.K.’s entry this year into double-dip recession. The limited nature of the FTSE 100’s recovery presents a problem for defined benefit funds that invested heavily in U.K. equities in the early 2000s, since their capital returns are still negative.

Pension scheme trustees are hoping, because of their effect on the discount rate, that this year’s extremely low gilt yields will prove more temporary than the sluggishness of U.K. equity price performance. The yield on 10-years has repeatedly fallen this year to new record lows. It has been depressed by both QE and the flight of investors from euro zone bonds, attracted by the U.K. government’s progress in trimming its large fiscal deficit.

The U.K. authorities have shown sympathy towards employers operating defined benefit schemes, when it comes to the increase in deficits caused by the probably temporary aberration in gilt yields. The Pension Regulator said in April that these schemes would be given extra leeway to help them survive until employers could top them up. “Low gilt yields have the effect of driving up current measures of pension scheme liabilities and as a result will typically worsen scheme funding levels,” it said. “Therefore, funding deficits may remain at the levels identified three years ago, or even higher for some schemes, despite significant deficit repair contributions over the last three years.”

The average defined benefit pension fund deficit was 33 percent of liabilities in 2011.

The Bank of England spent £325 billion on buying assets through QE between March 2009 and May 2012, and voted in July to spend another £50 billion. The program has been devoted “almost entirely” to gilts, notes the report.