It has been calculated that there is a £312 billion black hole in UK final salary pension schemes.

This figure from the Pension Protection Fund (PPF) is a massive increase on last year’s deficit of £24.5 billion.

This means that the employers running the schemes will have to put more money in to ensure that they pay out the guaranteed promised pensions. This could mean less money to invest for company growth or higher pay for example.

Pension funds carry a variety of assets (as determined by the individual fund rules), typically shares and bonds. The idea is to have a mix of riskier assets for long term growth (better return) and ‘safer’ assets (government bonds) for security as well as a variety of assets some accruing capital growth others attracting income.

Some people may point at the recent fluctuations in the stock markets to explain why the returns on the pension fund money invested are not sufficient to keep pace with the fund’s payouts. As the stock market drops the fund shrinks in size.

Others are also blaming the government’s policy of quantitative easing (QE), which hits government bond (gilt) yields. As the Bank of England buys government bonds through QE it drives up demand so pushing gilt prices up and therefore ‘yields’ down. The gilts are then bought by pension funds at a premium (more than their face value) so that when they are redeemed by the government the fund gets back less than they paid for them, with the hope that in the interim the ‘coupon’ (fixed interest) paid every six months on the bond would make the investment a good deal for the fund overall. It has been estimated that the £325 billion in current QE could cost the pension industry some £270 billion.

But this is only part of the story. One has to look a lot further back than the last few years to see other factors that have had an impact on pension funds.

A pension fund is a very long term savings vehicle. It will have to take money in, invest it through several business cycles (booms and busts) from the time a bright eyed and bushy tailed teenager starts their first job with a company to the point at which they are given their gold pocket watch, final pay packet and first pension pay out.

In between there will be a changing flow of new employees contributing and ex-employees claiming their pensions.

This means that the fund has to grow and also has to be very robust to protect itself from the ever changing economic climate.

So it would be a good idea to let the fund grow as large as it can in the good times, however whale-like it appears, so that when the lean times inevitable arrive, the fund can pay out and shrink but still remain fully solvent.

That means that governments should resist the temptation to see the fund as a cash machine when changing tax rules, like when Gordon Brown changed the tax credit rules for pension schemes effectively pulling a reported £5 billion a year out of the funds.

It also means that companies should not be allowed (or forced by the government) to take ‘holidays’ on their pension contributions just because the fund looks too big.

Money-Ian Britton via

Money-Ian Britton via

It sounded reasonable at the time, the pension funds are too big and the government could use some of the money for … whatever and the companies could use some of it for growth.

But both of these have meant that the funds have been starved of the money they really needed to make sure they still had enough money in them to pay out in the bad times – like they obviously don’t have now.

All this money that was not invested back then now needs to be put in. Pretty obvious eh?

Far from being seen as a success, the excessive growth of the pension funds should have been another indicator of an over-heating economy that would eventually have to crash. Had the money stayed in the pension funds maybe it would have been a small stabilising factor on the economy.

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