Bank of England’s guidance will impact both sides of scheme funding says Spence

Will Davison

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Spence & Partners, the UK pensions actuaries and administration specialists, have said that yesterday’s forward guidance issued by the Bank of England could have different impacts for UK defined benefit pension schemes across their liabilities and assets.

Marian Elliott, Head of Trustee Advisory Services, commented: “With the Bank’s intention to keep the base rate at 0.5% until an unemployment target has been reached, they will maintain the upward pressure on liability values of many UK DB schemes. Maintaining QE for the short to medium term may well stem the recent rise in gilt yields, which had been good news for schemes as this lowered the current value placed on pension liabilities. Until the unemployment conditions are met and interest rates begin to rise again, we would not expect pension liabilities to reduce significantly on the back of rising gilt yields.

“QE will have to be unwound at some point, which is likely to create inflationary pressure over the medium term, and the Bank will then face a significant challenge to meeting their 2% inflation target. Medium and long term inflation expectations have a greater impact on pension scheme liabilities than short term inflation, as they affect the expected future increases due on pensions in payment and revaluation of pensions in deferment – in most cases causing the value placed on liabilities to increase. Whilst the Monetary Policy Committee have said they will act should inflation
expectations “no longer remain sufficiently well anchored”, the Bank will be faced with competing
pressures and something will have to give.”

Elliott continued: “Whilst the outlook for liability levels is not rosy, schemes may find some comfort in the possibilities of growing their assets. One of the reasons the Bank is seeking to keep interest rates low is to promote economic growth that higher interest rates may stifle. So, if the plan works and economic growth increases, then with it we should expect real assets to increase as well. Many schemes retain a significant exposure to real assets, so strong performance could offset some of the detrimental effect that low interest rates have on the liability side of the equation. In addition,
a sustained recovery could result in a strengthening of the financial covenant available to schemes
from their sponsoring employer.

“Whilst the forward guidance was hardly a revelation, it did clarify the position of the new Bank of England leadership. Trustees would do well to consider how the stance the Bank is taking may affect their Scheme and to allow for this in their funding and investment decisions.”