Pension Schemes Forced Into Riskier Investments?

1 June 2015

Will Low Interest Rates Force Pension Schemes Into Riskier Investments? That's the warning that has come today in a new report from the Organisation for Economic Co-operation and Development's Business and Finance Outlook report. The report states that the current economic climate is presenting very serious challenges to both pension schemes and life insurers who may be facing the very real risk of not being able to meet their obligations to their members and policyholders.

The situation has arisen due to the fact that pension schemes often invest sizeable amounts into securities with a fixed income such as long term government bonds. However, the problem is these sort of investments that once used to perform well have fallen in value over recent years. This is due to a number of factors such as the gradual impact of the quantitative easing policies that have been introduced in the UK, US, Japan and Europe.

This raises the issue of what pension funds will do to increase their yields. This could lead them to undertake higher risk investment strategies, which obviously increases the risk to their solvency should these investments fail. Not only does that threaten financial stability, it could also threaten the secure retirement of their pension fund's members.

These concerns have been echoed by a number of leading industry figures. Mario Draghi, President of the ECB (European Central Bank) recently stated "A long period, a protracted period of very low interest rates, causes a series of problems," including a risk to financial stability"

The International Monetary Fund too also recently shared their concern, saying that "weak European midsize life insurers face a "high and rising risk of distress" from prolonged low interest rates".

As to how pension schemes will respond to these concerns due to continuous low interest rates is unclear. The solvency deficit for UK private sector pension schemes is estimated to be over £1trn, which presents a significant risk of a major financial fall-out should something go wrong. Options could include increases in fund contributions and even a complete overhaul of schemes for new members, although any changes for current members would be very unlikely.

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