QE is achieved by the BoE (which is of course owned by the UK Government) buying gilts issued by the UK Government. The sellers of these gilts will mainly be UK insurance companies and pension funds which hold them as investments. The money used to buy these gilts is created electronically, at the press of a button.
The idea is that the money created will be deposited by the recipients in their respective bank accounts in return for the gilts they sell to the BoE. This increases bank reserves and thus supposedly the ability of banks to lend to UK businesses. The money will eventually be “spent” by the recipients (on shares for example).
The value of the assets bought rises, confidence returns and the economic environment improves. So the ability of banks to lend increases, the supply of gilts falls (as more become owned by the BoE) and the price of shares will increase, or will fall less than they otherwise would. Well that’s the theory.
The problem is that no-one knows whether QE really works this way, as it is impossible to model what would have happened had QE not occurred. The aim is to increase economic activity by increasing the supply of money. Keynes once described attempts to increase economic activity by increasing the supply of money as "like trying to get fat by buying a larger belt".
In raising the total amount of QE to a total of £275bn, the BoE will have purchased gilts to the equivalent of:
- 19% of UK GDP,
- 32% of the total value of UK gilts issued, and
- 45% of the type of gilts the BoE will actually buy (maturities of three to 25 years).
Such a vast sum of “asset purchases” leaves less to buy in the open market, effectively pushing up the prices of gilts by draining their supply. This, as far as pension funds are concerned, is a nightmare.
QE may have the effect of increasing the price of shares to some degree (or causing them to fall less than they might otherwise do so), and so pension funds invested in shares will tend to rise in value (or fall less). Gilt yields will fall as their price rises and annuity rates will fall even further.
Imagine that you are a male aged 60, married with a spouse three years younger, and have a pension pot worth £300,000. Even before QE has its desired effect, this is sufficient to buy an annuity based on the options set out below:
| Option 1 (single life level annuity) | £15,216 a year |
| Option 2 (single life annuity increasing by RPI) | £8,256 a year |
| Option 3 (joint life level annuity) | £13,464 a year |
| Option 4 (joint life annuity increasing by RPI) | £6,600 a year |
Source: http://tables.moneyadviceservice.org.uk/Comparison-tables-home
Note: Options 1 and 2 include a five-year guarantee. Options 3 and 4 are based on a 33% reduction of the annuity on the annuitant’s death and no guarantee period.
If instead our 60 year-old male choses to go into drawdown instead of securing an annuity, the maximum income using the GAD tables that could be drawn would be just £15,300 per year.
The GAD tables calculate the amount that may be drawn down by reference to 15-year gilt yields. The current 15-year gilt yield rate for this purpose is just 2.75%. Once QE gets under way this should reduce further, as will the permitted drawdown and annuity rates generally.
You can see that, for those with defined contribution pension plans, to get a decent retirement income is almost impossible for most. When was the last time you checked the value of your pension fund?
For those with deferred pensions in final salary schemes, QE will cause scheme liabilities to rise – not good news if the scheme is already in deficit. Ironically transfer values should rise rise as well – fine if the scheme is not in deficit and can afford to pay increased transfer values.
Consider also public sector pensions (civil servant or teacher pensions for example). The increased scheme liabilities (and increased transfer values) are underwritten by the state. So QE has the effect of increasing the deficit when these liabilities are factored in. No wonder the Government wants to cut public sector pensions.
As the economic crisis continues to unfold, the pensions time-bomb that many have been warning of for years has just become today’s pensions nightmare.
