By Paul Sweeting
Over the last few years, central banks have made increasing use of unconventional monetary policy to stimulate economic growth. In the UK, quantitative easing (QE) has meant that the securities bought have been almost overwhelmingly government bonds: at the end of 2012, the Bank of England held £375bn in gilts, while it holds only £25 million in corporate bonds and no commercial paper at all.
While growth has been the motivation for this policy, pension schemes have also been seriously affected. Funding liabilities for pension schemes are driven by gilt yields: if yields are pushed down, liabilities – and, potentially, contributions – are forced up. While there might also be a beneficial impact on assets, it is far from clear what the net effect on pension scheme solvency might be.
We’ve carried out some research that looks at the impact of quantitative easing (QE) on UK pension schemes using a counterfactual model. This is a model that tries to say what would have happened to yields had QE not been implemented. Given that we know what did happen to yields because QE did occur, the difference between our model and reality can be attributed to QE.
The results of this analysis – which we apply to both conventional and index-linked gilts – are interesting. While the whole yield curve was depressed by the first round of QE (QE1), the second round (QE2) held down rates at the short end of the curve much more than the long end. This is important because pension scheme liabilities are impacted far more by long bond yields than the short end of the curve.
Of course, if QE pushed up the value of pension liabilities, it also pushed up the value of fixed income securities. However, even allowing for this offsetting effect, we found that QE1 raised UK pension deficits by around 16 percentage points, or £150bn. In contrast, QE2 – where long rates moved much less – had a much more moderate effect, which completely disappeared by the end of 2012.
QE probably had a positive impact on the value of other assets such as equities, though this is far more difficult to quantify. But even the most widely-quoted estimate of 20% uplift would not have cleared the QE1 deficit. With less than half of pension fund assets invested in equities, the improvement would have been 10 percentage points at most, and even this might not have been fully realised until the end of QE1.
These results are interesting for a number of reasons. First, it looks likely that QE1 increased pension deficits, meaning that any schemes carrying out funding valuations at this time would have to have committed to paying higher contributions. However, it also shows that the impact of QE on pension schemes has been diminishing over time. This could mean that any subsequent rounds of QE have a far milder impact on pension schemes. This isn’t to say that QE might have only a limited impact on yields; what it means is that the impact is likely to be more concentrated at the short and medium end of the curve.
Fundamentally, it means that while pension schemes suffered from the initial implementation of QE, the current impact is negligible.
Paul Sweeting is European head of strategy at JP Morgan Asset Management
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