Pension-fund deficits have soared by billions of pounds in the past few days after a sharp fall in yields on government bonds, financial experts said yesterday.
The total deficit for the final-salary pension plans of FTSE 100 companies has jumped by £35bn to £110bn in the past few weeks, according to actuaries at Deloitte. They said pension schemes had been hit by rising inflationary expectations and the fall in gilt yields.
The problem for pension funds is that their liabilities are calculated using a discount rate based on yields. If it falls they have to buy more to make up the gap, which in turn drives the price up and the yield down - creating a vicious circle.
Tony Osborn-Barker, a director in consulting at Deloitte, said: "What a difference two weeks makes. This is a direct result of the 'double whammy' that we always feared - a rise in inflation expectations and a fall in bond yields." Yields on 50-year index-linked gilts have halved since they were launched in September. On Wednesday they fell to a mere 0.38 per cent, barely more than one-third of the 1.112 per cent they were sold at last year.
In the past 15 years, real interest rates have collapsed from 4 per cent to less than 1 per cent, thereby raising pension liabilities. Aon Consulting, an actuarial firm, said total UK pension-fund liabilities rose by £28bn on Tuesday alone.
Donald Duval, its chief actuary, said: "This problem has been created by the Government. It compelled all company pension funds to guarantee all pensions against inflation, but then failed to issue enough index-linked gilts to enable pension funds to invest to match the liabilities which the Government had imposed on them."
Meanwhile the Pensions Protection Fund, set up to protect the retirement right of workers in companies that go bust, has set a 31 March deadline for companies to reveal the scale of their deficits, which could force them to buy more long-dated stock.
Mr Duval said unless the Government issued a huge amount of index-linked stock, this kind of market instability was likely to persist for several years. "Company pension funds will increasingly be faced with a stark choice - invest for the long term, and risk the wrath of the pensions regulator, and potential volatility in future pension costs, or buy protection against both at an inflated price," he said.
Analysts have called on the Treasury to issue more long-dated stock to meet demand, warning the surge in demand had created a price bubble that could burst with massive fallout for financial stability. So far, opposition parties have not sought to make political capital out of the crisis.
The Treasury and the Debt Management Office, its executive agency, are monitoring the situation. The DMO is scheduled to sell £650m of 2055 index-linked gilts next Tuesday.
Stephen Lewis, the chief economist at Monument Securities, said simply issuing more long-dated gilts would be a "short-run palliative. It is doubtful whether the DMO could indefinitely keep up with the potential demand for long-term assets."
He said politicians would be reluctant to scrap the new rules for fear of being accused of weakening consumer protection. "It would be ironic if the operation of prudential regulations brought about the collapse they were intended to ward off," Mr Lewis said.
S&N staff forced to contribute to final-salary scheme
The brewer Scottish & Newcastle has become the latest employer to seek to plug its pension deficit by forcing staff to begin contributing 6 per cent of salary if they wish to remain in the final-salary scheme.
The fund has a deficit of £400m and about 4,000 active members - one-third of S&N's UK workforce. The final-salary scheme was closed to new members in 2003. Employees hired since then have been put into a career-average pension scheme where contributions range from 0 to 6 per cent of salary.
S&N said members of the final-salary scheme had the option to switch into the career-average scheme if they did not want to begin making contributions. Previously, the final-salary scheme was non-contributory for staff. S&N's 10 per cent contribution will not change, although the company injected £200m into the scheme two years ago to help reduce the deficit.
The changes to the final-salary scheme take effect in April and have been accepted by S&N's employee council, which was advised by Alan Pickering, the independent pensions expert who produced a report on reform of the occupational pension system for the Government three years ago.
Meanwhile, the retailer John Lewis confirmed it may raise the retirement age for staff in its final-salary scheme from 60 to 65. About 34,000 of the 63,000 staff at the John Lewis Partnership's eponymous department store and its supermarket chain Waitrose belong to the scheme, which is non-contributory. John Lewis contributes 10 per cent of salary once partners have been there for five years.
The changes are designed to save £10m and help close the scheme's 15 per cent deficit. But they will have to be approved by the partnership's ruling council, which is elected by all partners.
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