Did UK Pensions Pay Too Much After QE1?
(April 25, 2013) — A new assessment of how quantitative easing (QE) might affect pension scheme funding has revealed UK sponsors may have paid in more contributions than was entirely necessary.
Modelling analysis from JPMorgan Asset Management – using the liabilities of the Pension Protection Fund’s scheme funding – has shown the impact of QE1 in 2009 was substantial, reducing solvency by up to 16%.
Employers were forced to put more contributions into their defined benefit schemes to improve their solvency – but question marks have arisen over whether, in hindsight, employers put too much into their pension pots.
Estimates from a Bank of England working paper written by J. Bridges and R. Thomas suggest equities may have increased by as much as 20% in the following months.
The result? If you were a scheme with a triennial evaluation in September 2009, you probably put in more in additional contributions than you needed to.
By comparison, the market reaction to QE2 in 2011 was more mooted – the impact on liabilities was far less than in 2009 and as a result, funding levels were less affected.
“By QE2, the market had got used to the Bank of England being a major participant,” said Paul Sweeting, head of strategy for Europe at JPMorgan Asset Management.
“For three years the market and investors had come to terms with QE and were used to it, so the second round had less of an impact on pension schemes funding, although it still affected 10 year rates.”
Sweeting’s findings came from his latest research paper “Not Drowning, But Waving” – which argues that the impact of QE on UK schemes’ funding levels was nil by December 2012, because of the lesser impact of QE2 and the rise in equities, and the fact that QE only has a major impact on short-term rates (five to 10 years).
“QE looks to have had a significant depressive effect on interest rates, and it appears to have been the main culprit for this,” said Sweeting.
“But while there has already been work on the impact of QE on rates, there has not been anything detailed looking at the impact on pension schemes, especially looking at the full period over which QE has been in place.”
Putting more cash into your plan is unlikely to be seen as a bad thing in the current markets, but the lessons of how QE affects scheme funding could provide useful in the event of a third round of asset purchases.
It should be noted there are a number of caveats – the model used by Sweeting is only applicable to the UK’s QE due to the Bank of England only purchasing gilts with the new liquidity, and it doesn’t take into account the other major events affecting markets – and therefore solvency – in the past five years.
The impact of risk assets in a QE-impacted environment is also largely ignored, because analysis of their movements was more difficult.
And even if the 20% rise in the value of equities could be proven to be accurate, it wouldn’t have been enough to eradicate the UK schemes’ deficits, since less than half of the schemes’ assets are invested in equities, Sweeting added.
Which all goes to show that the calculations around additional funding contributions may need deeper analysis than we first thought.
Related News: Japan Moves the Needle on QE