Deflation threatens company pension schemes for first time in 50 years

Published on Saturday 20 December 2008 14:28

DEFLATION will be the biggest risk for company pension schemes, which have already seen their deficits soar, an industry expert has warned.

Mark Wood, chief executive of Paternoster, an insurer which buys out pension schemes from companies wanting to shift their liabilities, said very few firms knew how to cope with a deflationary environment. There has not been deflation in the UK for almost half a century.

Wood, the former chief executive of insurance and pensions giant Prudential, told Scotland on Sunday: "We're going to have a new problem next year – that will be deflation. I think we're going to have a sharp little burst of deflation which will provide pension schemes with quite an issue. The majority of schemes have carefully worked out what happens as inflation rises, but very few have thought about deflation."

Deflation will lower the overall value of schemes' assets, according to Wood, but companies will only have limited scope to reduce pension provision. "I think we'll see quite wide deficits as a result of deflation," he said.

Consumer price inflation is already starting to ease off, with the Office for National Statistics last week reporting it fell sharply to 4.1% in November, down from a peak of 5.2% in September and 4.5% in October.

Jonathan Loynes, an analyst with Capital Economics, said: "November's UK CPI figures are another step along the path which is likely to lead to the first bout of deflation in the UK economy for almost half a century."

Deflation will be the latest blow to pension schemes, which have already been hit hard by plummeting stock markets. Recently, Scotland on Sunday revealed that nearly 10bn had been erased from the value of the country's private sector schemes this year.

Wood said the economic downturn had affected the valuation of corporate bonds which form part of pension scheme assets. Valuations are down as analysts expect a number of companies to default on their interest payments. "Basically default risk has gone up. None of us can be entirely sure what the default rate will be next year, so we're bound to be more cautious in valuing bonds," he said.

He is recommending that companies considering a buyout for their pension scheme hold off until a more "temperate" market exists. Given the current volatility, he expects a quiet start for the buyout market in the first half of 2009, followed by a pick-up that will lead to more business than this year.