Phew! Why your retirement income IS still safe

THE Bank of England’s dramatic £65 billion intervention has removed the immediate threat to pensions. If the schemes that were affected run into difficulty, the employer is still responsible for paying out pensions, and if the firm becomes insolvent, there is a Pension Protection Fund that steps in.

How many were at risk?

ABOUT ten million members of defined benefit pension schemes, otherwise known as ‘final salary’ plans, were affected. So-called defined contribution plans, where payouts are linked to stock market performance, were not involved.

Shouldn’t they be ultra-safe?

INDEED. That’s why the risks revealed are so shocking. As their name suggests, final salary schemes offer a retirement income linked to your pay when you leave work, guaranteed for life.

What went wrong?

PENSION fund managers are supposed to ensure they have enough in the pot to pay retired workers in the future. Among their assets are IOUs issued by the UK Government, known as gilts. These offer a fixed rate of return and can be bought and sold by investors. When the price of the gilts falls, the yield rises. Their value is influenced by how much faith investors have in the creditworthiness of the UK Government. The riskier they think the debt is, the higher the yield investors will demand.

What happened last week?

AS INVESTORS’ concerns mounted over the mini-Budget, they sold gilts. This caused yields to soar at an unprecedented rate in the normally sedate market.

I’m with you so far...

GOOD, because there’s more. Many pension funds use leveraged Liability Driven Investment (LDI) strategies. Simply put, the funds put up the gilts they own as collateral to borrow money, which they use to buy another investment.

They may repeat that process, and borrow again against the new asset, and repeat it several times.

But when, as happened last week, the price of gilts falls, the collateral is worth less. So lenders asked pension funds to stump up huge sums as additional security.

The speed and scale of the movements in gilt prices threatened to provoke a liquidity crunch, as the funds didn’t have the cash to hand, so were forced into a scramble to sell assets. Without intervention, it would have driven down gilt prices further and created a ‘doom loop’.

By stepping in and promising to buy up the gilts, the Bank has defused the ticking bomb.

How much of this went on?

LDIs have soared in popularity in recent years and now account for about £1.5trillion in assets held in people’s pension funds.

Did no one see the iceberg?

REGULATORS responsible for financial stability were repeatedly warned of the risks from leveraged LDIs – but did nothing.