UK Private Pensions are in trouble

by Shaun Richards

I thought I would take a look at a developing situation which affects across the age spectrum but in varying ways. We regularly note it as a consequence of other actions but it is time again to look at it directly. Earlier this month it even got a mention in the House of Commons.

“To ask the Chancellor of the Exchequer, what assessment his Department has made of the effect on pension companies of the decision by some UK listed companies to cancel dividend payments to their shareholders.”

He is opening a new front there by adding the lack of dividend payments to the lost of troubles and is mostly addressing occupational schemes but will affect personal ones too.The reply from Treasury Minister John Glen opened up the topic much more widely and the emphasis is mine.

Whilst dividend income is important for pension schemes, they have long-term investment horizons and a range of other sources including fixed income from corporate and sovereign bonds, rental income and capital gains,although many of these are under strain., 

When market conditions recover and firms have rebuilt their balance sheets we anticipate that dividends will be restored.

That last sentence about dividends is rather ominous as how often have we been told that something is temporary in the credit crunch era? Remember this from Deputy Governor Charlie Bean from a decade ago….

“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.”

A decade later we have still not arrived at the “times in the future” when savers will be “doing very well”. It is hard not to have a wry smile at the fact that this complete failure at forecasting is now on the Committee of the Office of Budget Responsibility which compiles the fiscal forecasts for the UK ( for newer readers they are always wrong).Still at least his pension arrangements got a top-up in return for working half the week.

Your fee is determined by the Treasury and paid by the OBR, and will be £5,140.55 per month, less statutory deductions as mentioned below.

The Underlying Problem

Much of this has been driven by the policy of the Bank of England so by Sir Charles and his successors.They cut interest-rates to 0.5% in a supposedly emergency move and more recently Bank Rate has gone to 0.1% with expectations that it will go negative. For our purposes the next bit has been in my opinion an even stronger influence on pensions.

The Committee voted unanimously for the Bank of England to continue with its existing programmes of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, maintaining the target for the total stock of these purchases at £745 billion.

This has been the factor that has driven the corporate bond and sovereign bond yields mentioned in the Treasury statement earlier, lower. This makes life very hard for pension and indeed other funds which rely on an income stream to make payments and oil the wheels. Indeed, as regular readers will be aware, up to around the 6 year maturity UK bond or Gilt yields are in fact negative at around -0.05% as I type this.Imagine having to explain to pensioners that you are investing their money for an expected loss! Also that such a loss will be before inflation which will only make matters worse.

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This afternoon the Bank of England will do its best to make that situation even worse as it buys another £1.473 billion of short-dated UK bonds and hence tries to make yields even more negative. It will buy other maturities tomorrow and Wednesday meaning the total will be a bit over £4.4 billion, this week. If we look out as far as we can then even the 50 year yield is a mere 0.68% which in nominal terms offers very little and after inflation looks set to offer large losses.

If we switch to dividends we see another wasteland as the numbers below from Simon French of Panmure Gordon highlight.

The UK equity market has seen dividends cut by 31% in 2020, and has left the Top-10 dividend payers making up 52% of FTSE All Share dividends. Median dividend yield on UK equities now just 0.8%, having been 2.3% at the start of the year.

There are various technical reasons for this as well as the simple basic one that it has been a rough year for economies.For example we see that in many countries including the UK banks which used to be high dividend payers have restrictions on payments. Also the troubles of the oil and gas sector have hit dividend payments there as the latest payment from BP ( for the second quarter) was a bit under half that of last year.

As to the issue of capital gains there have been some for those who have invested in technology stocks such as the FAANGs. But on a wider more generic level the situation was sung about by Lyndsey Buckingham.

I think I’m in trouble,
I think I’m in trouble.

If we look at the UK FTSE 100 equity index it is at 5840 as I type this. So since the peak of 7877 in late May 2018 there have in back been capital losses. More grimly if we try to look back in time to avoid the ebb and flow we see that it ended the previous century at 6930. So equity investments have in fact lost and not made ground this century.

Taking a Pension

The usual system in the UK is to take an annuity as it offers a guaranteed income for life. Back on the 19th of March 2015 I looked at them.

If you crunch the numbers for a basic (single life no add-ons) annuity at age 65 then it takes around 17 years to get your money back. This is awkward and leads to the view that an annuity is bad value.

The situation is now quite a bit worse as you will get a yield of 4.79% or it will be around 21 years before you get your money back. This situation affects both final salary schemes and those with a personal pension.

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The numbers get even worse if you want inflation protection. There is a payment needed foe that but you see due to all the QE bond purchases described above index-linked bonds are worth much more than the inflation in them. Or if you prefer they offer bad value too.

Comment

As you can see there are a lot of challenges for pension funds. This has been an ongoing issue as this official denial from the Bank of England in 2012 highlights.

Asset purchases are likely to have had a broadly neutral
impact on the value of the annuity income that could be
purchased with a personal pension pot.

As even by then annuities had fallen how did they get to this?

But the flipside of that fall in yields has been a rise in the price of both bonds and equities held in those pension pots.

Since then the FTSE 100 has risen by at most 100 points and many investments made on a monthly basis have been at a loss. Even they could not avoid this point.

By pushing down
gilt yields, QE has reduced the annuity rate

The impact here has been like a bomb going off for those with private pensions. For personal schemes it has been the lack of growth and for occupational it has been the way the schemes have struggled under increasing burdens leading to worsening terms and many schemes closing. If we look ahead what future is there here for those investing for their future right now?

Of course the Bank of England was right about its own pension scheme which has the equivalent of a sugar daddy as this from the Guardian in 2016 shows.

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. Most private employers pay 5-10% of salary into pensions, with many large companies struggling to cope with widening deficits in their schemes.

But for the rest of us we are left mulling the words of the Queen of Hearts.

My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.

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