What does bond market turmoil mean for pension members?

The last week or so have been turbulent times for pensions with grim headlines about the Bank of England having to step in and save pension schemes from going insolvent. It has left people worried about the future and what it means for their retirement savings. However, it is important to realise the UK pension system has weathered many shocks over the years and while events have been unnerving it remains robust.

The situation involved a number of defined benefit (DB) pension schemes who employ what is called liability driven investment (LDI) strategies.

These strategies are extremely popular and involve a scheme investing a portion of its assets for growth while the other part is invested to track its liabilities – liabilities being the pension income a scheme needs to pay out now and in the future. These liabilities are sensitive to changes in things like interest rates and inflation and so the scheme effectively buys insurance against movements in these areas – often called hedging.

We’ve seen interest rates rise markedly in recent months and so schemes were being asked to plough more money into these hedges, often at short notice. Many schemes were able to meet these cash calls but those who weren’t sold assets – such as gilts – to get the cash.

Crisis

The situation was turned into a crisis given the fall out of the government’s so-called mini-Budget on Friday 23 September. Concerns about how the Chancellor was going to raise the money to pay for sweeping tax cuts had already sparked a large scale sell off in the gilt market.

Schemes coming into the market to sell more gilts caused prices to fall even further and the yield to spike even more. This meant the number of calls for cash increased further.

This caused a dangerous tailspin that prompted the Bank of England to intervene in stabilising the market by pledging to buy up UK gilts over a period of around ten days – for the sum of £65 billion. Support which Andrew Bailey, Governor of the Bank of England said could end on Friday 14 October.

The speedy intervention certainly calmed the situation but has led to longer term concerns about the safety of pension schemes.

First of all, it’s important to say that predictions of the large-scale collapse of pensions are way off the mark. It’s true there were some pension schemes that experienced difficulty during this time, but the Bank of England’s intervention gave them much needed breathing space to shore up their position and make sure they remain in the best possible position.

It’s also worth saying most schemes were able to navigate the situation without having to sell assets. There are other schemes who emerged from the situation in a better situation than before.

For those people in a DB scheme, it’s also important to say that the investment risk is taken by the employer, not the member and if members are promised a certain level of pension income then they should continue to receive that.

The only caveat is if the employer were to be declared insolvent. In this case the likelihood is the pension would go into the Pension Protection Fund and if members are over pension age when this happens you continue to receive your full pension. Younger members will receive a reduced amount – around 90%.

Defined contribution

But what about people in a defined contribution scheme? These pension members weren’t involved in the gilt selling mayhem, but the likelihood is they will have experienced investment losses as a result of the market turmoil.

Again, it is important not to panic. Pensions are a long-term investment and those with some years to go before retirement will have time to make up any losses. Pensions will experience periods of extreme market turbulence that can result in investment volatility, but markets do recover so it’s wise to steer clear of knee-jerk reactions such as changing investments or cutting contributions as these can crystallise losses.

Those coming up to retirement may be unnerved to see investment losses so close to retirement. However, if they are expecting to annuitise their pension they will be comforted to see the annuity market is one area to benefit from the current environment. Annuity rates are tied to long-term gilt yields and as they rise then so do annuity incomes. This year alone incomes have risen by around 35% so this will bring a cushioning effect.

People who wish to go into income drawdown should check how their investment performance has been impacted. Most people will be invested in their scheme’s default fund, many of these adopt a lifestyling strategy which moves people from equities to bonds/gilts over time. If this is the case, then it’s possible they have seen falls in fund value. Again, the fund should recover over time and in the meantime, people may wish to delay taking income from their pension, or else opt to take a smaller income for a period of time.

Keeping one to three years’ worth of essential expenses in an easy access cash account is one way for people to supplement their income while their fund recovers.

Important information: What your employees choose to do with their pension is an important decision. They should check they’re making the right decision for their circumstances and that they understand all their options and risks. The information in this article isn’t personal advice but we can offer financial advice if you’d like it.