DB schemes 'at their healthiest' since before onset of Covid-19

UK defined benefit (DB) pension schemes reached their 'healthiest' level since before the onset of Covid-19 in Q3 2021, according to Legal & General Investment Management's (LGIM) Health Tracker.

The tracker showed that the average DB scheme can expect to fund 98.3 per cent of accrued pension benefits as of 30 September 2021, a rise of 0.1 percentage points on the 98.2 per cent seen in both March and June 2021.

DB funding levels have been gradually improving since falling to a 91.4 per cent low in March 2020, amid the immediate impact of the pandemic on the financial markets.

Despite the improvement, LGIM warned that these figures may still understate the negative impact of the pandemic, due to weakening covenants from pension scheme sponsors, which many schemes have endured.

LGIM head of solutions research, John Southall, commented: “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.”

Adding to this, LGIM head of rates and inflation strategy, Christopher Jeffery, said: “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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