Brian Tora column.

Byline: By Brian Tora

There have been reports suggesting that, despite the last year's stock market rise, the UK pension fund deficit is increasing.

How can this be, you might ask? Perhaps more important, what exactly is this deficit and does it really matter?

Not many people understand what this is all about and fewer still are concerned. In this case, a little more knowledge could lead to a great deal more worry.

Pension funds - or at least those set up by companies for their employees - generally fall into one of two camps: defined benefit or defined contribution.

This latter approach, which is pretty much how personal pension schemes operate, is also known as money purchase. What members of these schemes receive on retirement depends on how much is in the fund when benefits are drawn.

A defined benefit scheme, on the other hand, needs sufficient to meet the stated liabilities of the scheme. It is in these final salary schemes where black holes exist.

While these schemes do not have to invest in the stock market, in practice equities have been the asset class of choice for pension fund managers over many years.

This is hardly surprising, given that ordinary shares are considered to offer the best long-term prospects for capital appreciation and income growth.

And so they did, until the new millennium. The bear market that followed was savage. But even if the stock market fall triggered the deficit in defined benefit schemes, (and undermined with-profits life funds), it is only half the story. Pensions are generally provided through annuities and the return from these depends on the yields attainable on long-dated Government securities.

The fall in inflation and interest rates in the 1990s stimulated a bull market in fixed- income stocks that drove yields down on long gilts - at one point to below 4pc. Low long-dated yields mean low annuity returns. So, pension providers must spend more to maintain the provision they promised.

Those who cast their calculating eye over pension schemes are saying that the rise in the value of shares has been insufficient to offset the fall in yields at present achievable for those retiring. Bad news for personal-pension investors about to retire, but should it really affect final salary schemes?

Sadly, it does. Recently established accountancy rules demand that companies make full and proper provision for their pension scheme members. Black holes are simply not allowed. The inevitable result is that final salary schemes are fast becoming extinct.

It is remarkable to reflect on what is happening and realise that much is the unintended consequence of actions or events.

Gordon Brown could not have known the withdrawal of tax concessions for pension funds would coincide with the worst bear market in a generation. Low interest rates are generally welcomed, yet they have exacerbated the pension shortfall. And new accountancy rules, meant to tighten processes, have led to benefits being withdrawn. It is, indeed, a funny old world.

* Brian Tora is Investment Communications Director at wealth manager Gerrard Ltd.