UK Plc’s total deficit now stands at £710bn, the biggest level ever, according to PwC’s Skyval Index.
Defined benefit pension schemes – those which guarantee an income linked to savers’ final salaries – face a bigger deficit when interest rates fall as they struggle to earn strong, low-risk returns, reports The Telegraph.
“The conditions we’re experiencing now are driven by the market’s expectation of unprecedented lows of long-term interest rates. It is indirectly linked to the base rate – the industry is acclimatising to the idea of lower yields for longer,” said PwC’s Raj Mody.
“Six months ago yields were pretty low and people thought surely they can’t get any lower and they have to go up. Then we had the referendum vote which was a shock to markets, as was the Bank of England stimulus package, so there is now this expectation we’re in this lower for longer yield environment which is driving up this funding deficit measure.”
The Bank of England cut its interest rate to a new record low of 0.25pc in early August.
The rise in the deficit over the past month is the only the sharpest in a long series of increases. Over the past year the total deficit has risen by £170bn.
As a result companies are faced with the choice between pumping more money into their pension funds, or pushing the funds to invest in riskier assets in the hope of earning bigger returns and closing the gap.
The deficit study came as Carclo, a plastics supplier, said falling bond yields have pushed up its pension deficit to such an extent that it is unlikely to be able to pay the dividend it announced on 7 June.
“We’re likely to see more of this kind of announcement in coming months, unless there is sharp pick up in bond yields,” said Tom McPhail, head of retirement policy at Hargreaves Lansdown.
“Current monetary policy may have kept the economy going but it is killing pension schemes, with disastrous consequences both for any employers sponsoring a final salary scheme and for any individuals looking to buy an annuity.”
Even before the latest interest rate cut, some big firms had to take drastic action to plug their pension deficits.
Earlier this year Royal Bank of Scotland said it would pump £4.2bn into its pension scheme to fill an accounting deficit, while last year Tesco agreed to pump hundreds of millions of pounds per year into its retirement savings pot.
Retailer Sir Philip Green is also under pressure to fill defunct high street chain BHS’s £571m pension deficit.
Mr Mody said that pumping in money is not the only solution – firms could make more use of the new pension freedoms, as some savers may want to take more money earlier in their retirement, reducing the deficits.
Companies could also adjust their investment portfolios to boost returns.
“I suspect pension schemes’ asset strategies haven’t be modernised or updated to allow for these new market conditions – they are probably based on beliefs about economic conditions from years ago,” said Mr Mody.
“Even six to 12 months ago the prognosis for our economic future was different to what it is now. They need to ask, is this the right structure, is it delivering the right risk-reward profile for the world we’re now in.”
