DB funding levels recover to near pre-Covid levels

The average defined benefit (DB) pension scheme funding level has almost returned to pre-Covid levels as of the end of September, according to Legal and General Investment Management (LGIM).

LGIM's health tracker showed the average DB scheme can expect to pay 95.5 per cent of accrued benefits, as of 30 September 2020, representing a 2 percentage point increase from June 2020.

The firm emphasised that this is also just one percentage point below the pre-Covid levels of 96.5 per cent in December 2019, as well as a “significant improvement” on the figures from March 2020, when the average funding level dropped to 91.4 per cent.

Commenting on the findings, LGIM head of solutions research, John Southall, stated: “It’s great to see things improving once again this quarter.

“As previously, however, we would caveat that these higher ratios may understate the negative impact of Covid since the start of the year, due to a weakening of covenants that many schemes will have endured."

"The extent of covenant deterioration is not yet clear," he added, clarifying that these calculations are based on a typical sponsor rating of around BB.

He warned that if this were to fall to a B rating the expected proportion of benefits met would likely be around 2 per cent lower, effectively wiping out the gains seen this quarter.

The firm attributed the recent improvement in funding levels to significant market movements, including the strong performance of growth assets and an increase in nominal interest rates, whilst inflation expectations remained broadly the same.

LGIM head of rates and inflation strategy, Christopher Jeffery, explained that the gilt market has downgraded the likelihood of negative interest rates from the Bank of England in 2021 and beyond following breakthroughs in a search for the vaccine and the US election.

However, he warned that RPI reform is “now around the corner” with an announcement pending in late November, and constitutes the “next major event risk” for DB schemes to navigate.

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