The ongoing UK problem with pensions

Today has brought a piece of news that is another element in an ongoing saga. It also brings into play some economic developments that are interrelated to it. Oh and a past manipulation of the UK public finances. From Reuters.

Royal Mail said on Thursday it would close its defined benefit pension scheme at end-March 2018 after a review found it would need to more than double annual contributions to over 1 billion pounds to keep the plan running.

Royal Mail, the British postal service privatised in 2013, said it was one of only a few major companies that still had employees in a defined benefits scheme, a type of pension that pays out according to final salary and length of service.

The company, which pays around 400 million pounds a year into the scheme, said it was currently in surplus, but it expected the surplus to run out in 2018.

There are various initial consequences such as threats of strike action from the postal union and something to cheer central bankers everywhere. From the Financial Times.

Investors were more positive about the plan, however. Shares in Royal Mail rose 1.6 per cent after the announcement to their highest level since January. JPMorgan Cazenove analysts estimated last month that markets have already priced in a £100m a year step-up in pension charges, and investors have welcomed signs of an end to questions over the scheme’s future.

UK Public Finances

Those who recall my analysis from 2013 will remember that this is another version of the Royal Mail pension scheme that was originally booked in the UK National Accounts for a £28 billion profit! How can you have a profit on acquiring something which is unaffordable? Later the methodology was quietly changed.

This reflects the shortfall between the £28 billion of assets transferred from the RMPP and the £38 billion of future pension liabilities that were consequently assumed by Government…….. Furthermore, the transfer of the assets no longer reduces borrowing as it did under ESA95.

To be fair to our statisticians and indeed Eurostat they did catch up with this manipulation eventually but of course by then the public’s attention had moved elsewhere.

Why are these pension schemes now so unaffordable?

The latest report from HM Parliament describes the problems and issues.

poor investment returns, associated with low underlying interest rates and loose monetary policy following the 2008–09 financial crisis and associated recession;8


rises in longevity that have been faster than was widely anticipated;


sponsor behaviour, including many employers taking contribution holidays when schemes were in surplus.

Only actuaries and economists can make rising longevity seem a bad thing! But if we move to the effect of low interest-rates there is this evidence from Deputy Governor Ben Broadbent to HM Parliament on this and the emphasis is mine.

First, I don’t think it damages the value of their assets; it pushes up the price of their liabilities. That is what happens when bond yields fall. The price of that bond and the present value of the liabilities go up. But it also pushes up the assets.

Even with such analysis Dr.Ben was forced to admit that schemes in deficit were net losers. But I find the overall idea that they lose on the swings but gain on the roundabouts simply extraordinary! Another example of Ivory Tower thinking. You see they have present gains although of course they will be across many markets but the real issue is that they have to pay for future liabilities and the answer misses of the fact that pension funds have going forwards to buy assets such as bonds which are much more expensive. Indeed in an odd but true development pushing up the price of ordinary UK Gilts via QE has in some ways had more of an effect on index-linked Gilts which are not bought! This matters because most defined benefit schemes have inflation based liabilities to pensioners.

The odd case of index-linked Gilts

Because ordinary Gilts offer so little interest these days and index-linked Gilts offer annual coupons based on the Retail Price Index ( 3.1%) if you need income then linkers look more attractive. Of course the price adjusted to this but this means that the Index-Linked Gilt market is in quite a bubble right now. It also means that it is in a way not fit for purpose as it is being priced on annual cash returns rather than inflation prospects as we see yet another market which has been turned into a false one by the central planners.

I have written before about how you could lose money by being right about UK inflation and this is why. So how do pension funds now hedge inflation risk?

The UK Gilt market

This has been on something of a surge recently or perhaps I should say another surge. Let me put an apology in with that because that has wrong-footed my stated view on here as I expected it to fall as inflation prospects deteriorated.  But  the ten-year Gilt yield is quite near to 1% and the two-year yield is 0.1% which is insane in terms of real yield with inflation heading to 3/4% depending on the measure used. Pension funds look a long way ahead so if we look at the thirty-year yield we see it has fallen to 1.63%.

Thus if we switch to prices we see that any investment now is at an extraordinarily expensive level. What could go wrong?

Actually according to HM Parliament defined benefit schemes tend to value themselves versus the higher quality end of the Corporate Bond market.

scheme funding statistics show that discount rates used by DB pension schemes for calculating liabilities since 2005 have consistently been around 1 per cent above gilt yields.

Can anybody spot a flaw in the Bank of England buying £10 billion of these ( £9.1 billion so far) to raise the price and reduce the yield?

Pre pack problems

Another issue was raised by Josephine Cuombo in the Financial Times.

Companies in the UK have used a controversial insolvency procedure to offload £3.8bn of pension liabilities, often as part of a sale to existing directors or owners, a Financial Times investigation has found…….

The FT investigation found that two in three pre-pack schemes entering the PPF involved sales to existing owners or directors. A string of prominent cases that used pre-pack arrangements, but where companies are still trading, include the turkey producer Bernard Matthews, the bed company Silentnight and the textile group Bonas.

In essence the schemes have found their way into the Pension Protection Fund which is backed by the industry thus raising costs for other schemes and pensioners get reduced benefits.


When the Bank of England looks at pensions it is hard to avoid the thought that views are influenced by their own more than comfortable position. For example in its latest accounts Ben Broadbent had received pension benefits valued at £104,586 in the preceding year. It is also hard to forget that just as it was telling everyone inflation was going lower back in 2009 the Bank of England piled into index-linked Gilts in its own scheme! But for everyone else involved there are no shortage of sharks in the water.

As to the befuddled and bemused Ben Broadbent he has views which question why we pay him at all!

One thing I want to get across today is not to confuse the low level of interest rates with monetary policy…….

Even though we are that last link and even though it is the MPC that sets interest rates, it is not a realistic question—I do not think it is a realistic premise to say low interest rates are because of monetary policy.

Until of course he can claim gains from his policies….

Let me sign off for a few days by wishing you all a very Happy Easter.




14 thoughts on “The ongoing UK problem with pensions

  1. Hi Shaun
    So the Post Office continues with
    a first class pension and a second class service.
    I think that the pension companies use
    the term “smoothing” for their current massaging, I think that smothering would be
    more accurate.
    Happy Easter Shaun and once again thankyou.


    • Hi JRH

      As to the Post Office service it outperforms the private letter services that deliver mostly junk mail to me ( but ocassionally something relevant) but nothing like what it once was.

      Happy Easter

  2. Happy Easter, and all readers – I’m off to Lyme Regis myself to do my bit for the UK economiy (well, my wife says gambling and hookers is not allowed so what’s left?)..

  3. Thanks for a great summary Shaun, although disappointed you didn’t slide in a cheeky “bootiful” for the Bernard Matthews pre-pack.

    I think you could write a very useful blog post on the other side of the pensions coin; the high level of transfer values being offered to former members of DB schemes. I’ve involved in advising someone age 55 who worked for a FTSE100 company and has been offered a TV of 47 times his accrued pension. Now bear in mind he is ten years from scheme retirement age. Even Ben Broadbent would understand these figures; the critical yield required to match the benefits is only just in whole numbers!

    Once again we see QE benefitting the “haves”, in this case people like Ben and particularly his ex-colleagues on the MPC who “have” transfers available from DB schemes. Those who “have not”, members of DC schemes, are paying the cost in reduced income through low annuity rates, or having to take higher risk through flexi access drawdown. There’s potentially a whole world of hurt when the markets turn…

    Have a good easter everyone.


    • Hi Andy

      You have me there as I did not think of “bootiful” as I typed away. You are right about the extraordinary valuations which I was reminded of on Monday when I did the calculations for the pensions scheme of the ( soon to be disgraced) Sir Paul Tucker and came up with ~£6.5 million. This is of course way over the theoretical caps for the like of us even if we had the money….

      Wasn’t it Andy Haldane of the Bank of England who said he does not understand pensions? Odd that considering how well his has performed.

      Happy Easter.

  4. Great article, Shaun. I’m not sure whether pension schemes have ever really been in surplus if that means they could pay all members their accrued rights for life, index linking and all.
    My view is that they have always been Ponzi schemes i.e. Fine for those at the start of the plan but disastrous for everyone else.
    The problems have only really come to light because low interest rates have made it clear to everyone (except the BoE) that the whole pensions industry is a disaster now. Even actuarial smoothing cannot hide it any more.
    It’s almost incredible that the pensions cap has been reduced repeatedly just as you need more and more to get anything like a decent pension.
    1. The Bank of England staff are just fine thank you very much
    2. The rest of us are completely screwed by the bank’s policy of QE
    3. I wish that I’d never put a penny into a pension and just put the money into houses
    Have a great Easter- I’m doing my bit for the economy in the west country

    • Hi James

      I am glad to see those of you who are going away are having staycations and boosting the UK economy. There should be room as I just met a friend in Battersea Park whose mum and sister have come up from the West Country to visit him for the long weekend.

      Happy Easter.

  5. I think the answer to the question “So how do pension funds now hedge inflation risk? is they can’t with the current market distortions. I was in a final salary scheme which has only just been closed to further accruals and has assets of about £1billion versus liabilities of £1.6billion (the plan is that ongoing funding by the company will allegedly eliminate the deficit by 2042). The fund trustees gave a talk to staff where one statistic caught my ear, namely that the fund deficit would increase by £60million for every 0.25% that inflation exceeded the reference level assumed by the actuaries. In other words 0.25% more inflation adds 10% to the existing £600million deficit. That seemed to me like an admission they couldn’t protect against inflation.

    • Hi Redshift and welcome to my corner of the web.

      I think Greece got these first in terms of plans to eliminate financial problems by 2042! Those inflation numbers you quote back up my point about index-linked Gilts but they are still somewhat scary aren’t they?

  6. Hallo Shaun, I’m confused. I thought the Government had agreed to shoulder all arising liabilities of the Royal Mail Pension Scheme when Royal Mail was sold into the Private Sector? That was when the Government declared a “profit” to which you refer. So why does Royal Mail have to pay £400 million pa into the scheme?

    Happy Easter!

    • Hi Jive Bunny

      My understanding is that the UK government or more realistically the taxpayer picked up what might be called a legacy pension scheme. A new one was started in 2012 and it looks as though it has not taken long for it to spiral out of control.

  7. I’ve heard some extraordinary words come out of the BoE in the last 10 years; but some words from Ben Broadbent exceed all incredulity . Befuddled and bemused is being very kind.

    Happy Easter Shaun.

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