Slow-burning financial crisis that threatens to engulf the globe
The latest developments in Britain’s pensions landscape have got rather lost of late among the more brutal items dominating the domestic news agenda.
But when two of the UK’s most prominent employers — BT and BHS, the collapsed retailer — reveal large shortfalls in the funding of their pension schemes, it should strike a louder chord than it seems to have.
BHS may be an idiosyncratic case — former owner Sir Philip Green is accused of neglecting the interests of pensioners in the run-up to the chain’s collapse.
The case of BT, where management is struggling to close the gap between the fund’s £43bn of assets and its vast £53bn of liabilities, is more broadly instructive.
As attention focuses on immediate threats to economic stability — from low growth to vast asset bubbles — few have the focus or the stomach to heed the ticking pensions time bomb
Last week the fund, one of the world’s biggest private-sector schemes, published an update on its finances. The report details the funding gap facing the scheme’s 300,000 members. For hundreds of millions of other people — anyone with the dream of a decent pension income — it illustrates the broader truths about a slow burn financial crisis that threatens to engulf the globe over the next decade or two.
As attention focuses on immediate threats to economic stability — from low growth to vast asset bubbles — few have the focus or the stomach to heed the ticking pensions time bomb. Inside it is a lethal mix of low investment returns, stubbornly high charges and insufficient contributions. The 2008 financial crisis was caused by low interest rates, greedy bankers and politicians pushing a euphoric agenda of perpetual growth and universal home ownership. It all blew up within a decade.
This one threatens to be all the more devastating because some of the factors behind the last crisis still persist, just supercharged by today’s extreme macroeconomic policies. As investor Bill Gross of Janus Capital warned recently: the $10tn of negative-yield government bonds is a “supernova that will explode one day”.
Against that alarming background, consider the micro-lessons of the BT story. In some ways, Britain’s former telecoms monopoly has been doing very well. Its investment returns have bucked the market and boomed. Last year, the S&P 500 delivered barely 1.2pc including reinvested dividends and hedge funds made just 0.04pc on average. Yet BT’s pension fund generated an 8.3pc return. BT also did more than many scheme backers and raised its contributions, adding £1.8bn. Despite these boosts, its funding deficit increased by £3bn, as paid-out liabilities accelerated and the discount rate applied to future liabilities — pegged on the declining yields available on corporate bonds — fell further.
Given that kind of corrosive macroeconomic underlay, pension funds that lack robust sponsors, and the luck, judgment or risk appetite to generate the BT scheme’s returns, will have fared far worse — and will do so as long as ultra-low interest rates continue. A recent report by Citigroup shone a light on just how big a nightmare is looming. It found most pension plans in the US and UK are underfunded, with an aggregate 18pc deficit.
Government pension schemes are in an even worse state. Citi found the value of unfunded or underfunded liabilities for 20 Organisation for Economic Co-operation and Development countries is $78tn — nearly double the $44tn published national debt number.
The pressure on companies and governments is clear. But these paternalistic ‘defined benefit’ schemes are decreasingly common. In most cases, employees these days are responsible for their own retirement planning — paying into ‘defined contribution’ schemes, sometimes with employer top-ups, sometimes not. Here, perhaps, is where the greatest risk for the next generation of retirees resides. The authorities compound matters. Despite persistently low interest rates — and anaemic investment returns — little adjustment has been made to official return guidance. The UK regulator, for example, still reckons a middle-of-the-road annual return is 5pc, making realistic retirement planning impossible.
Defusing the pensions time-bomb will be a huge challenge, if the world finally hears it ticking. In the meantime, there is one measure companies, governments and individuals could take in this environment — make more of those ultra-low interest rates and divert economies they make elsewhere to boost contributions to their pensions.
Published in Dawn, Business & Finance weekly, June 27th, 2016