Pension liabilities increase by nearly £100bn in May to a record £312.1bn

The estimated combined deficit increased by almost £100bn during May to reach £312.1bn by the end of the month the PPF, which pays compensation to members of defined benefit pension schemes if their employers go insolvent, said. Of its 6,432 member schemes 5,503 are now in deficit, with only 929 pension schemes recording a funding surplus. The schemes recorded a deficit of £24.5bn at the end of May 2011.

The PPF 7800 Index, issued monthly, is based on the combined section 179 liabilities of the defined benefit pension schemes potentially eligible for entry to the PPF. This refers to the liabilities schemes have under section 179 of the Pensions Act 2004, which broadly represent the premium that scheme would have to pay to an insurance company to cover a payout that matches the level of compensation its members are entitled to receive from the PPF - usually lower than the full scheme benefits.

The PPF is funded by eligible defined benefit pension schemes, which are schemes that promise a set level of pension once an employee reaches retirement age no matter what happens to the stock market or the value of the pension investment. It pays compensation to scheme members whose employers have become insolvent, meaning that they can no longer afford to pay the pensions they promised.

Last week the final salary pension scheme belonging to department store House of Fraser became the latest high-profile casualty of unsustainable rising costs, according to the Daily Telegraph. Staff will retain the benefits they have earned to date under the scheme, and have the option of transferring to a less generous company plan.

The record deficit had been fuelled a sharp drop in gilt yields as a result of the Government's £125bn quantitative easing (QE) programme and turmoil in the eurozone, according to the pensions industry. Yields fell by 55 basis points resulting in a 7.6% increase in pension scheme liability in May alone, according to the PPF, with a fall of 173 basis points over the course of the year to May 2012.

Joanne Segars, chief executive of industry body the National Association of Pension Funds (NAPF) pointed out that pension fund assets were higher than they were 12 months ago, according to the report, with the increased deficit reflective of liabilities which had "risen disproportionately".

"Quantitative easing and international investors seeking a safe harbour from the euro storm have contributed to a sharp drop in gilt yields," she said. "That gilt fall has fuelled this record deficit, which is more a reflection of accounting rules on pensions rather than any structural weaknesses. This is a volatile monthly index and it is important to remember that pension funds work over a long timeframe that helps absorb the effects of market swings."

However, she acknowledged that "cash strapped businesses that are already struggling" would be under "immense pressure" to find more assets to make up scheme deficits. Guidance (7-page / 85KB PDF) issued by the Pensions Regulator earlier this year warned that although struggling employers would be given more time to address deficits, those who "could afford to do so" would have to direct available cash from other projects.

Gilts are government securities. Their prices have been pushed up as a result of the Bank of England's QE programme resulting on the 'yield', or return, on that investment falling as a percentage of the price. QE allows the Bank of England to inject money directly into the economy by buying assets from private sector institutions such as insurance companies, pension firms, banks or other companies and crediting the seller's bank account. This means the seller has more money to spend or invest, while the seller's bank has more money 'on reserve' to lend to other customers.

Final salary and other defined benefit pension schemes are particularly affected by QE because they invest heavily in gilts. Lower gilt yields and long-term interest rates affect a formula known as the 'discount rate', which is used by the scheme actuary to calculate the cost of providing all the benefits currently promised during the scheme's regular valuations.

A report in April by the House of Commons' Treasury Select Committee called on the Government to consider measures to lessen the impact of QE on pensioners and savers as part of the Chancellor's Autumn Statement.