Deepening pension deficits leave UK companies diverting more capital from the real economy

The Telegraph carried an interesting article discussing how the lack of return on savings under zero interest rate and quantitative easing policies has triggered the Retirement Plan Death Spiral for both companies (aka the Pension Plan Death Spiral) and for individuals.

This article confirms your humble blogger's analysis that current monetary policy generates its own headwinds which make recovery from a bank solvency led financial crisis impossible.

It also confirms the observation made in the 1870s by the father of modern central banking, Walter Bagehot, that interest rates should never be set lower than 2%.

JLT Pension Capital Strategies ... said the total deficit stood at £55bn on June 30 compared to £33bn a year earlier. 

Eleven FTSE 100 companies have pension liabilities that are greater than their equity market value; BAE Systems, BT and RBS are committed to paying out pensions that are worth more than double their market value. 

The deepening deficit hole has been caused by factors including poor returns on equities and the Bank of England’s quantitative easing programme, which pushes up the price of government gilts, creating lower returns for pension funds.... 

Please note the cause of the pension plan assets not generating the expected returns.

“We have reached the stage where scheme deficits are widening substantially on an annual basis,” he said. 

Blue-chip companies are trying to plug the gap with capital injections while looking for alternative sources, such as property investment, to fund their pension schemes. 

If the FTSE 100 companies are staring into an abyss, smaller companies are going bust on a regular basis because they can no longer finance their pension schemes.... 

Please note the damage done to the real economy as companies shift funds from reinvestment in the real economy to paying for pension liability.  Demand is lowered and a negative feedback loop is established.

Companies have generally shifted towards defined contribution pension schemes, where a company makes contributions or matching contributions to a pension but doesn’t guarantee future payments to the employee, as they can’t afford defined benefit schemes where the employee has a fixed amount guaranteed on retirement. 

Some companies are responding by making the employees responsible for saving enough for their retirement.

This feeds into the Individual Retirement Plan Death Spiral.

“We have to face up to the fact that DB’s gone and DC’s coming,” said Mr Cowling. 

The auto-enrolment scheme, which kicked off on October 1, is a defined contribution plan which will see millions of workers gradually included in an automatic pension scheme, although a report from JLT launched at the Liberal Democrats’ party conference in Brighton said minimum compliance with the scheme would not secure a comfortable retirement. 

The consultancy estimated that an employee paying the 8pc default contribution would have to work eight years beyond the current retirement age – to 76 – to achieve the recommended pension of two thirds of final earnings. 

The government has said the contribution rates were set to ease people into saving and individuals should aim to save more if they can. 

To have enough to retire on, individuals have to cut back on their current demand.

Given that individuals account for almost 70% of demand, their cutting back current demand puts tremendous downward pressure on the economy.