UK DB funding levels improve since the onset of Covid-19, but sponsor health remains top concern, says LGIM

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For the first quarter since the onset of the pandemic, the health of the UK’s Defined Benefit (DB) pensions schemes failed to improve, ending what had been four consecutive quarters of growth. However, it should be noted that funding levels remain far stronger than their pre-Covid levels, according to Legal & General Investment Management (LGIM).

LGIM's Health Tracker, a monitor of the current health of UK DB pension schemes, found that the average1 DB scheme can expect to pay 98.2 per cent of accrued pension benefits as of 30 June 2021, the same figure recorded on 31 March 20212.

The health of the UK’s Defined Benefit (DB) pension schemes had originally dropped as low as 91.4 per cent as of 31 March 2020, following the onset of the pandemic, having previously been at 96.5 per cent as of 31 December 20194. LGIM’s monitor has since shown a continuing improvement in each of the last four quarters, which has been brought to an end with the latest data.

This suggests that UK’s Defined Benefit (DB) pension schemes may well have completed their initial recovery from the pandemic. However, it is important to note that these figures may yet still understate the negative impact of the pandemic, due to a weakening of covenants that many schemes will have endured.

John Southall, Head of Solutions Research at LGIM, says: “Over the second quarter, growth assets continued to outperform but interest rate levels fall back somewhat. This partly reversed the very sharp rise seen in Q1 – the largest quarterly increase in nominal rates seen in years. However, interest rates remain substantially higher than at the end of 2020. Other factors including relatively high experienced inflation and some technical revisions to our assumptions also led to some modest losses in Expected Performance of Benefits Met (EPBM), such that overall, it was flat over the quarter.

“Sponsor health remains a key concern as we move forward. As for the previous quarter, we chose to retain a typical sponsor rating assumption of BB in our calculations. This assumption reflects covenant strength, impacting the security of benefits and our EPBM measure. The long-term impact of the pandemic remains unclear, however, we noted that if a rating of B was assumed, the EPBM figure on 30 June 2021 would be around 1.2 per cent lower.”

Christopher Jeffery, Head of Rates and Inflation Strategy at LGIM, adds: “Global bond markets recovered some of their poise in the second quarter despite unexpectedly high inflation prints across Western economics. Investors are buying into the narrative from central banks that price pressures will be transitory rather than permanent. In turn, that has allowed equity investors to shrug off concerns about the spreading delta variant and focus instead on the continued strength in the profit recovery. With earnings growth so strong, we think the positive tailwind to risky assets is set to persist.”