DB schemes at their healthiest since Covid-19, but pandemic may cast long shadow

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The UK’s Defined Benefit (DB) pension schemes are at their healthiest since before the onset of Covid-19, as of Q3 2021, according to Legal & General Investment Management (LGIM).

LGIM's DB Health Tracker, a monitor of the current health of UK DB pension schemes, found that the average1 DB scheme can expect to fund 98.3 per cent of accrued pension benefits as of 30 September 2021. This is a rise of 0.1 percentage points from the figure of 98.2 per cent recorded three months before on 30 June 2021.

The health of the UK’s DB pension schemes had been gradually improving since March 2020, when it had dropped as low as 91.4 per cent3 as a result of the immediate impact of the pandemic on financial markets.

However, while these figures suggest that the health of UK DB schemes has been improving since the initial spread of Covid-19, it is important to note that these figures may yet still understate the negative impact of the pandemic, due to weakening covenants from pension scheme sponsors, which many schemes have endured.

John Southall, Head of Solutions Research at LGIM, says: “Inflation expectations rose to their highest levels since 2008 with the bond markets implying a substantial risk that the rise in inflation may be more than transitory.”

“This has made it more challenging for DB schemes to meet their unhedged inflation-linked liabilities. However, a relatively modest (but still substantial) rise in nominal interest rates, combined with respectable growth asset performance, meant that overall our Expected Proportion of Benefits Met (EPBM) measure still managed to post a small gain.”

“As for previous quarters, we chose to retain a typical sponsor rating assumption of BB in our calculations. This assumption reflects current covenant strengths. However, the long-term impact of the pandemic on DB schemes’ health remains unclear. It is worth noting that if a B rating was assumed instead, the EPBM figure would be around 1.2 per cent lower.”

Christopher Jeffery, Head of Rates and Inflation Strategy at LGIM, adds: “Since the end of the second quarter, yields on short-maturity government debt around the world have risen sharply as markets prepared for the turn in the monetary policy cycle. That same dynamic has played out in the UK with increasing focus on when, not and if, the Bank of England raises interest rates. However, long maturity bond yields have confounded widespread expectations of a material sell-off. At the end of the third quarter, 30 year gilt yields were only marginally higher than in Q2  and that was before the sharp falls in recent weeks triggered by the reduction in government bond supply and the Bank of England’s “wait and see” decision in November. Yet again, the rumours of the death of the gilt market have been greatly exaggerated.

“Risk asset markets suffered a small wobble towards the end of the third quarter before quickly recovering their poise. Investor risk appetite remains robust in spite of increasing headlines about supply chain disruptions crimping growth and lingering pandemic concerns. With high household savings as a critical shock-absorber, we find it hard to worry too much about the economic outlook and remain comfortable with equity risk over the medium-term.”

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