Problems with Pensions- (22.01.06)

If there is a Pensions crisis in the UK, then Government involvement may not be the answer to it. This may prove to be the classic case of where Government involvement to avoid what is seen as a market failure may cause the market to fail.

New Government regulations of corporate pension schemes control the funding and investment of schemes. This encourages pension schemes to seek long term (50 year) bond investments to match the liabilities that they face, rather than relying on short term movements in equity investments. This is a logical Government reaction to the risk of pension schemes failing that would result in the members then relying on welfare support in old age.

The Government however also controls the market for long term bonds. Therefore the supply of these is tightly controlled by the Government for public finance purposes. The market for these bonds therefore becomes highly illiquid and the yields from these bonds subsequently drops. Because pension regulation links the funding requirement of the schemes to these yields, the problem with pension becomes self fulfilling.

So how should a Government react? Clearly the market for bonds needs to become more liquid. The easiest way would be for Pension funds themselves to issue long term bonds, along with more long term Government debt. A more liquid market would probably result in increasing yields. The Government would also then need to show more flexibility on pension funds being required to purchase these bonds. Without this flexibility, there is a risk that any Government policy towards pensions will fail as the policy itself will create a different market failure to the one that is trying to be corrected. Perhaps an independent regulator should regulate the pensions regulations, or at least the issuing of long term debt by the Treasury.