Is your retirement pension safe amid Bank of England chaos?

Why was there suddenly a problem for some final salary schemes?

The gyrations in the financial markets of the past few days put their finances under pressure. The details are complex as schemes use sophisticated techniques, in conjunction with investment banks and derivative contracts, to ensure they have enough income to pay pensions to members. 

In times of severe stress in the government bond markets, of the kind witnessed in recent days, the pricing of these contracts spikes and requires the pension funds to commit huge amounts of cash to investment banks as collateral. This is why a sharp rise on bond yields caused panic among pension funds who were at risk of their cash calls exceeding how much they had in assets.

What did the Bank do and did it work?

The pension schemes’ methods for managing risk can come unstuck if gilt prices change suddenly. This is exactly what has been happening, so the Bank acted to stabilise them. 

Gilt prices had been falling sharply and the Bank said it would buy them in whatever quantities necessary. The sudden appearance of a major new buyer put supply and demand back into balance and stopped the price from falling further.

However, this week investors became increasingly anxious about the support’s looming end date on Friday. This triggered another bout of selling, prompting further action from Threadneedle Street. 

What if the Bank’s actions do not work? Should I take action to protect my pension?

Pension savers should not take any action – it is unwise to make long-term decisions based on short-term volatility.

Members of final salary schemes are very well protected. First, the scheme’s managers and trustees are required by a strict regulatory regime to keep it adequately funded. Then, if it finds itself short of money, it can ask the employer concerned to contribute more. 

Finally, there is a lifeboat scheme, the Pension Protection Fund, if the employer fails. This ensures that pensioners receive all, or almost all, of their entitlement.

Experts have also noted that higher yields could actually be beneficial for defined benefit schemes’ financial health. Sustained higher yields improve the valuation of defined benefit pension schemes, because the value of their future liabilities – the money they promise to pay to their members when they retire– are discounted by government bond yields. 

Overall, the funding of final salary schemes has improved this year due to higher rates. As of the end of September, over three-quarters of Britain’s 5,200 defined benefit pension funds were estimated to be in surplus, according to the Pension Protection Fund. 

Those who do not have a final salary pension and instead save via a workplace or personal defined contribution pension are not directly affected by the Bank’s decisions. However, their investments may rise and fall depending on market movements in the short term.

Does the fall in the pound affect pensions?

Mr Bailey’s firm message that the Bank’s bond-buying programme will end on Friday triggered a sharp drop in the pound, which is now trading at around $1.097.

This reflects investors’ fears around the economic outlook in Britain and the credibility of the Government and the Bank.

It does not, however, have a direct impact on pension savings apart from where it affects specific investments.