There are plenty of problems faced by pensions and long-term saving

Even a cursory glance at the news will tell you that there is a lot of rumbling discontent in the pensions arena. There has been the issue over NHS doctors pensions, the WASPI women and today a strike over pensions by those who work at universities. I rarely directly dealt with them as they were a colleagues responsibility but back in the day the Universities Superannuation Scheme had a very good name. In many ways these are symptoms of credit crunch themes so let us take a look at them. But our musical theme is provided by Queen and David Bowie.

This is ourselves under pressure
Under pressure

Low and negative interest-rates

Pressure was applied by the initial cuts to official interest-rates but this was ramped up when the bond purchases of QE were added to it. This was a deliberate attempt to reduce bond yields which in many ways are the lifeblood of many types of pension.As ever we were promised it would be temporary as this from Bank of England Deputy Governor Sir Charles Bean from September 2010 shows.

 “It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.”

I am afraid that he took us for Charlies back then as over nine years later we are still waiting and as I shall explain in a moment matters deteriorated. As to Sir Charles he is “doing very well” as not only did he retire with a large Bank of England pension that somehow managed to be fixed to the “flawed” RPI measure of inflation but he is now at the Office for Budget Responsibility.

If we moved forwards to August 2012 our warning klaxon was triggered as we saw an official denial.

For those approaching retirement in ‘defined contribution’ schemes, lower gilt yields as a result of QE have
reduced annuity rates. But it is crucial to allow for the fact the QE has raised the value of pension fund assets too. Once allowance is made for that, QE is estimated to have had a broadly neutral impact on the value of the annuity income that can be purchased from a typical personal pension pot invested in a mixture of bonds and equities.

There always were issues with that an even it could not avoid pointing out this.

But schemes that were already in substantial deficit before
the financial crisis are likely to have seen those deficits increased.

Also the deflector screens were in operation which is a bit odd don;t you think when there is apparently no problem.

The paper notes that the main factor behind increased pension deficits and falls in annuity incomes has not
been the Bank’s asset purchases, but rather the fall in equity prices relative to government bond prices.

If we look at their last point this remains true and is much of the problem. The UK FTSE 100 has gained over 1600 points since August 2012 according to my monthly chart but the 50-year Gilt yield has plunged from 3.09% to 1.18%. So what we were told was temporary has become permanent. Regular readers will be aware of the bond market surge we have seen and in fact it was even stronger a couple of months ago when the UK 50 year yield went below 1% for a time.

The Problem

Let me now address the consequence of this which twofold. If you have a pension fund to invest in and draw from ( DC or Direct Contribution) then your annuity rate and hence pension will be low. Added to the bit that allows for the risk of you dying ( sorry for the grim bit) is a mere 1% or so. So whilst you can take 25% as a lump sum and it is tax-free the other 75% does not pay much. A single life annuity at 65 pays just over 5% so many will doubt if they will even get the sum invested back and this is with no inflation protection.

Next comes another development which has hammered final salary or Defined Benefit schemes.The trends were against them as we have looked at above but it got worse as some investors noted that you got get more yield from RPI linked Gilts than conventional ones and drove the prices even higher. This meant that the costs of a DB scheme got higher/worse and meant they were likely to continue to thin out in number.

You do not have to take my word for it as here is the Bank of England.Remember it saying in 2012 that things were neutral? Well by 2016 apparently not.

It has emerged that employees, led by the Bank’s governor, Mark Carney, received the equivalent of a 50%-plus salary contribution into their pensions last year, underwritten by the taxpayer.  ( The Guardian )

Pensions Law

Back in the days before the credit crunch I was involved in some pensions work and took the advanced qualification called AF3. I stopped because they kept changing the rules and it would have been a case of perpetual study! But even more seriously the rule changes have tripped over each other and ended in the mess that is doctors pensions. Most would want them to be covered but as the limits were cut no-one seemed to think that it could cost consultants to work for the NHS. As fast as they earned money this raised their pension value and they were/are taxed on it.

NHS England has set out plans to pay off pension tax bills for doctors who breach the annual allowance limit on pension growth in 2019/20. ( GP Online)

So there is an apparent fix but what about others who have been tripped up by changes which have turned out to be in some senses retrospective? I suspect professors are part of the USS dispute although what we have looked at already is an issue.


This is a problem because of the way that they are measured.

The pensions industry uses something called a ’discount rate’ to calculate the present value of the
scheme’s liabilities………….. The liabilities must be measured using the current yield on high quality
corporate bonds – usually AA rated bonds – regardless of how the how the trustees of the pension
scheme invest their assets

What do you think has happened here in the credit crunch era?


The arrow flying into the heart of pension saving has been the persistence of low interest-rates and bond yields.They have been not only “temporarily” low for a decade but have gone even lower. Buying an index-linked Gilt now guarantees you a negative real yield if you make a long-term investment which frankly defeats its/their whole purpose.

If we switch to the WASPI issue there is another mess. Back in the early to mid 1990s it was decided that men’s and women’s state pension ages would be equalised rather than women getting theirs at 60 as opposed to 65. In many ways it seemed fair although of course some would be adversely affected.This was sped up in 2011 but has been a policy in motion under governments including all 3 main parties in the UK. Was this unfair? If so it is hard to see how changes could be made and also what about higher retirement ages generally? Even worse plans to change this seem to mostly benefit the better off. So I have tried to avoid the politics but yet again we end up with short-term manoeuvring around a long-term issue.





Carillion highlights the many problems of credit crunch era pension financing

This morning’s news brings us back to a problem which has dogged the credit crunch era. The advent of first official interest-rate cuts and then central bank balance sheet expansion was designed to pull economic demand from the future to the present. This poses an issue for pensions as it does for all long-term savings contracts as they rely on the future. The issue has become clearest when we look at a consequence of the widespread monetary easing which was reflected in a question on Thursday to ECB ( European Central Bank) President Mario Draghi which mentioned “10 Trillion” dollars of negative yielding bonds. If you start doing any sort of maths you find that the negative yields imply you will be getting less back in the future than you pay in now and that is before you factor in the impact of inflation. Who invests to make a loss?

Putting it another way here are the real yields as of today from Germany. Not what economics 101 would predict for am economy in a boom is it?

Just for clarity some of the nominal yields are negative as shown in the chart but even when they go positive they are negative if we allow for inflation prospects and estimate a real yield.


This reflects the conceptual issue as we note that its business model was to take advantage of the era of monetary easing. Take a look at this from the House of Commons Briefing Paper.

Over the eight years from December 2009 to January 2018, the total owed by Carillion in loans increased from £242 million to an estimated £1.3 billion – more than five times the value at the beginning of the decade.

So it was able to borrow on a large-scale as we note an effect of these times which is often forgotten. Not only did it become cheaper to borrow for many purposes but there was an availability of credit meaning that Carillion could borrow ever more as well as cheaply. As an aside the banks would no doubt have been happy to make some business lending but as I reported many years ago now about Japan you don’t always get the sort of business lending you want as we note what it did with it.

In the eight years from 2009 to 2016, Carillion paid out £554 million in dividends, almost as much as the cash it made from operations. In the five years from 2012 to 2016, Carillion paid out £217 million more in dividends than it generated in cash from its operations.

Now let us skip to the pensions situation.

Carillion has 13 UK defined benefit pension schemes with 27,000 members. In January 2018, the trustees estimated that the schemes’ Pension Protection Fund (PPF) deficit (the shortfall compared to what is needed to pay PPF compensation levels) was up to £900 million

So shareholders got dividends and we know the directors were well paid and were able to think of the future. From the Financial Times.

Allowing clawback conditions to be changed a year ago, striking out corporate failure as a reason to take back bonuses.

Yet they were somewhat more forgetful about the futures of others.

When did this start?

Rather concerningly the problems were long-standing. From Josephine Cumbo in the Financial Times.

In written evidence to the Committee, Robin Ellison, chair of Carillion pension scheme trustees, said the trustees had tried to agree higher funding contributions from the company in 2008, 2011 and 2013.

Even worse there are higher estimates of the problem emerging from the woodwork.

In his letter to the committee, Mr Ellison revealed that the funding shortfall for five of the six Carillion pension funds he chairs widened from £508m in 2013 to around £990m in 2016 when measured on a “technical provisions” basis. This is the measure used to set contributions from the employer every three years. However, the “buyout” deficit, or the measure used by the Pension Protection Fund to value a creditor claim for the pension debt, is nearer £2bn according to Mr Ellison.

This brings us to the subject of the regulator as we wonder what it has been doing over the past decade?

On Monday, the Work and Pensions Select Committee published new evidence claiming that the Pension Regulator (TPR) was alerted to problems with the company’s main pension plans as long ago as in 2008, when the scheme’s trustees and the company were locked in a funding dispute.

We seem to be back to the issue of who regulates the regulators as this looks like the behaviour of yet another paper tiger.

What is a pensions deficit?

In theory this is easy as it is simply an expected future shortfall. The problem is that more than a few variables are unknowable such as investment returns, inflation and interest-rates and yields in the future. The modern era started in 1997 with the Minimum Funding Requirement which had an impact on the markets I was working in/on at the time. From HM Parliament.

it appears to have created some extra demand in the long end of the gilts market, which may have contributed to the depression of yields.

This led to the view that one of the aims of the MFR was to support the Gilt market. Then another issue arose which has continued which is the use of yields to value pensions as only a year later there was a big change for dividend yields in pension funds.

the dividend yield is no longer a reliable measure of “value” for UK equities – this is partly due to the abolition of tax credits on UK dividends in the July 1997 Budget, which
has changed companies’ behaviour over profit distribution, and partly because investors are willing to value shares on future long-term expectations, despite the
absence of dividends or profits

More recently we have seen corporate bond yields used for pension deficits but this has brought its own problems as central banks have intervened here. Firstly by making them more attractive by cutting interest-rates then reinforcing it via balance sheet expansion via bond buying. Then explicitly by actually buying corporate bonds as the Bank of England did in August 2016 and less obviously via the ongoing ECB programme as UK companies do issue Euro denominated bonds.

The irony of all this is that if you had bought long-dated UK Gilts two decades ago you would have done really rather well especially if you sold to the “Sledgehammer” buying of the Bank of England as it sent the market to all time highs with its panic inspired move.

What about direct contribution pensions?

These are simply ones where you put money in ( and if lucky your employer does as well) and it is invested and you make or loss depending on how the investments do. This is different to the schemes above where the employer promises a return based on your salary or earnings. According to the Financial Times just over a week ago the costs here are not quite what we are told.

The total cost of investing in popular funds, including those run by Janus Henderson, BlackRock and Vanguard, is up to four times higher than first thought, FTfm can reveal today. The Mifid II trading rules, which came into force this month, have forced asset managers to disclose hidden charges.

Some care is needed as platform charges are not caused by the fund management group but there are charges which are far from transparent.


There is much here to consider. The concept of investing for the future is simple and yet the credit crunch era has made it more complicated. For example there was a time ( and no doubt regulatory rules still suggest it) that the safest investment was a government inflation or indexed linked bond. No we see a time when in the UK and Germany you are pretty much guaranteeing yourself a loss in real terms if you hold them to maturity. If we look at conventional bonds they yield so little there is no fat on the bone as real yields are hard to come by.

Ironically this will have benefited some as if you had been holding bonds over the ,long-term then you are quids ( Dollars, Euros,Yen) in as we have been in a bull market. More recently equities have joined that party but here is the rub. In my opinion central baking easing has helped drive this too as current investors/pensioners benefit from borrowing from future returns. The claimed “wealth effects” must make it harder to make money going forwards as we note that like in Japan zombie companies which is what we are increasingly looking at with Carillion were indeed propped up.

Meanwhile I would suggested that especially if we consider their student debt burden millennials are unlikely to be able to buy a home and invest in a pension simply by giving up takeaway coffee and avocado toast.

Also I am pleased to report that the spirit of Sir Humphrey Appleby is alive and kicking at the UK Pensions Regulator.

The Regulator said: “It is too early to comment on whether with different information we could or would have taken action in the past or whether we will take action in the future, based on any new information that comes to light.” ( h/t @JosephineCumbo )