Pension risk as Bank of England investigates negative interest rates

If UK interest rates go negative there will be implications for pensioners. Here’s who may be affected.

Negative interest rates could hit retirees with final salary pension schemes by increasing their deficits and making it harder to fund payouts, experts warn.

The Bank of England’s monetary policy committee (MPC), which sets interest rates, signalled in September that the base rate may have to be reduced from its current 0.1% to become negative in order to stimulate lending and boost the economy.

Sam Woods, deputy governor at the Bank of England and chief executive of the Prudential Regulation Authority, wrote to banks this week to “understand the operational implications of implementing a negative or zero policy rate.” 

“For a negative Bank Rate to be effective as a policy tool, the financial sector – as the key transmission mechanism of monetary policy – would need to be operationally ready to implement it in a way that does not adversely affect the safety and soundness of firms,” Woods wrote.

However, there are also warnings that negative interest rates will increase deficits at defined benefit (DB) pension schemes, as it will reduce the income from bonds that are used to fund payouts to scheme members.

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It comes as pension scheme deficits are already growing, making it harder for them to fund retirement payments.
Data from the Pension Protection Fund (PPF) this week revealed that the combined deficit of UK pension schemes increased by almost £26 billion in September to £166.1 billion.

The PPF says: “The value of scheme assets is affected by the change in prices of all asset classes, but owing to the volume invested and the volatility, equities and bonds are the biggest drivers behind changes.

“Bonds have a higher weight in asset allocation, but equities tend to be more volatile.”

Joe Dabrowski, head of DB at the Pensions and Lifetime Saving Association (PLSA), says negative interest rates would have a number of impacts on final salary schemes. 

He says: “Savers would clearly see lower benefit increases in payment and in deferral, but perhaps most impactful would be the likely increase in scheme deficits, due to the way schemes calculate their liabilities. 

“This could lead to increased calls on employers to pay in more over their recovery plan, or re-visit their schedule.”

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Dabrowski adds that schemes would need to weigh the risks of later employer deficit payments versus their confidence in the employer funding it. 

He says:

“Alongside this, they may also need to look at their investment strategy to seek whether they need to make returns elsewhere – potentially increasing the overall risk in their portfolio.”

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