Negative interest rates are truly 'negative' for pensions

The quantitative easing measures implemented by central banks to resuscitate growth have been a disaster for retirement plans

Sweden's central bank governor Stefan Ingves has said negative rates were always meant to be 'a temporary measure', and that the central bank would 'most probably' raise borrowing costs when it meets on Thursday. Photo: ReutersShow less

It’s becoming increasingly apparent that the negative interest rates introduced in several countries in the wake of the global financial crisis are trashing bank profitability. Less obvious, though perhaps more crucial for society as a whole, are their debilitating impact on pension plans. And that’s why the days of sub-zero borrowing costs may be drawing to a close.

A 1 per cent decline in interest rates increases calculated pension liabilities by about 20 per cent.

Later this week, Sweden’s central bank is poised to abandon the negative interest rate policy it’s pursued for half a decade by increasing its key policy rate to zero even though inflation is expected to remain stubbornly below target for years to come.

Riksbank Governor Stefan Ingves has said negative rates were always meant to be “a temporary measure”, and that the central bank would “most probably” raise borrowing costs when it meets on Thursday. There’s been some pretty stern criticism of the likely move, with former central banker Lars Svensson condemning the plan for being based on an “irrational fear” of negative rates.

There’s nothing irrational, however, in fearing the economic consequences of keeping borrowing costs below zero for a sustained period of time. The emergency measures introduced to resuscitate growth, including central banks expanding their balance sheets by embarking on quantitative easing (QE), were supposed to be transient. Instead, they’ve become fixtures of the economic firmament.

It’s been disastrous for pension plans. A 1 per cent decline in interest rates increases calculated pension liabilities by about 20 per cent. It reduces the funding ratio, which measures a pension provider’s ability to meet its future commitments, by about 10 per cent. Those estimates come from a survey of 153 European pension providers with €1.9 trillion (Dh7.77tn) of assets sponsored by Amundi, Europe’s biggest asset manager, and published by Create-Research earlier this month.

As a group, European pension plans are in more trouble than ever before. Almost a quarter have funding levels of 90 per cent or below, with fewer than a third enjoying more than 100 per cent cover of their future liabilities, according to the survey. Moreover, 40 per cent are suffering negative net cash flows, compared with 33 per cent enjoying positive flows.

They blame a lot of their woes on the actions of central bankers, with 62 per cent of respondents agreeing that “QE has overinflated pension liabilities”. Half said they felt that “QE has undermined the longer-term financial viability of pension plans”. That’s quite something, especially given that the bulk of respondents reckon the bond-buying policies pursued by many central banks have become ineffective.

With about $11.7tn (Dh42.97tn) of the world’s debt yielding less than zero, the funds that run pension plans are anticipating meagre returns from the assets they manage.

Those low returns store up trouble for the future. It’s especially worrying as responsibility for putting aside retirement cash is increasingly transferred to individuals and away from companies and governments. Danish central bank Governor Lars Rhode went so far as to call the burden unacceptable: “The task of bolstering the pension system to withstand pressures from lower rates and higher dependency ratios cannot be delegated to the individual pension saver,” he said earlier this month.

At the moment, a halt to the extraordinary policy measures introduced in the wake of the global financial crisis may not seem imminent, with the US Federal Reserve having backtracked on its efforts to normalise borrowing costs and the European Central Bank restarting its QE programme earlier this year. But doubts about the ongoing usefulness of such extreme monetary actions are growing.

Pacific Investment Management Company (Pimco) joined the chorus last month, with Nicola Mai and Peder Beck-Friis saying in a report that sub-zero rates “create significant challenges” for the pensions industry. They argued that the prevailing “negative rate policy does not have much further room to run” as the unintended consequences become more and more apparent.

If the Swedish central bank’s newfound scepticism about the efficacy of negative rates becomes as widespread as its previous enthusiasm for sub-zero borrowing costs, relief could be in sight for pension providers — and the workers depending on their nest eggs to fund a comfortable retirement.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable".