The Bank of England’s decision to cut interest rates in response to the coronavirus crisis have driven defined benefit deficits higher, with UK pension schemes facing a funding hole of £166.1bn by the end of September.
These figures show that deficits have increased by £26bn in the space of a month, and over the past year aggregate deficits have risen by almost £50bn, with plummeting gilt yields the main cause of these problems.
AJ Bell has warned that these problems could worsen if the Bank of England is forced to cut interest rates from the current level of 0.1 per cent, and move towards negative rates.
AJ Bell senior analyst Tom Selby says: “The aggregate deficit of UK defined benefit schemes remains eye-wateringly high at £166 billion, driven in large part by the Bank of England’s interest rate policy in response to Covid-19.
“Low central bank interest rates place downward pressure on Government gilt yields, which is bad news for DB pension schemes as this pushes up the value of liabilities.
“While the value of investments held on behalf of DB members has recovered since the market lows of March and April, persistently low gilt yields are working in the opposite direction.
“And with tougher lockdown measures coming into force this week and the Bank of England warning negative interest rates may be needed to keep the economy afloat, it is possible DB deficits will rise still further as the UK claws its way through the remainder of 2020.”
He points out that with the Government reducing the amount of financial support available to businesses, it is inevitable some will go bust.
This is likely to present a challenge for the Pension Protection Fund, which is responsible for paying a portion of the pensions owed to members of failed companies.
Selby says: “Individuals in DB schemes worried about the future should take some comfort from the existence of the PPF, which provides a valuable lifeboat guarantee meaning you should get at least 90 per cent of the value of your pension.
“Furthermore, a deficit is just a measure of the funding position of a DB scheme at a point in time. Arguably the most important thing is the health of the company ultimately responsible for paying your pensions.
“For firms already facing severe challenges in the face of Covid-19, having to deal with a rising DB deficit is clearly far from ideal. Many businesses will likely face a difficult balancing act in plugging these deficits while also investing the necessary cash today to ride out the current crisis.”