Anyone who is a member of a pension scheme will be alarmed by the news that the Bank of England has intervened to save them.
But is your pension in danger? We explain what today’s events mean for your pension.
What types of pension plans has the Bank rescued?
Its actions concern final pay or “defined benefit” schemes in the private sector, schemes that pay employees a percentage of their salary upon retirement. These pensions are considered the gold standard because they are guaranteed and do not rely on investment performance. They are also inflation-linked.
Final pay schemes are becoming increasingly rare in the private sector. Their more modern replacement, defined contribution schemes, work differently and therefore do not require any action from the Bank.
Virtually all final pay schemes in the public sector also work differently. These are funded by the employer on a pay-as-you-go basis, supported by the taxpayer if necessary, so that they were not at risk.
Why was there suddenly a problem with some final pay plans?
The fluctuations in the financial markets of the past few days put pressure on their finances. The details are very complex because these schemes use advanced techniques, in collaboration with other parties such as investment banks, to balance their assets with their obligations to members.
In times of severe stress in government bond markets, as we have seen in recent days, these techniques no longer work to reduce risk and instead increase it.
What did the Bank do and did it work?
Retirement plans’ methods of managing risk can be confused if gold prices suddenly change. This is exactly what happened, so the Bank has taken action to stabilize them.
The gold price had fallen sharply and the Bank said it would buy them in any quantity. The sudden appearance of a large new buyer rebalanced supply and demand and kept the price from falling further.
What if the Bank’s actions hadn’t worked? Would my pension have been in jeopardy?
Members of final pay plans are very well protected. First, the administrators and trustees of the system are required by a strict regulatory regime to keep it adequately funded. If he is then short of money, he can ask the employer concerned to contribute more.
Finally, there is a lifeboat scheme, the Pension Protection Fund, if the scheme fails. This ensures that retirees receive their entitlement in full or almost in full.