DB pension scheme health continues to improve past pre-Covid levels

The health of the UK’s defined benefit (DB) pension schemes has continued to improve since the sharp decline seen at the start of the pandemic, with analysis from Legal & General Investment Management (LGIM) suggesting that it is “far stronger” than pre-Covid-19 levels.

The provider’s Health Tracker, a monitor of the current health of UK DB pension schemes, found that the average DB scheme can expect to pay 98.2 per cent of accrued pension benefits as of 31 March 2021, representing a 6.8 percentage point year-on-year increase.

Indeed, the tracker has shown a continued improvement in each of the last four quarters, with the latest figures also marking a 1.1 percentage point improvement on the previous quarter, with a funding level of 97.1 per cent recorded as at 31 December 2020.

Despite this, the provider stressed that it is important to note that these figures may still yet understate the negative impact of the pandemic, due to the weakening of covenants that many schemes will have experienced.

LGIM head of solutions research, John Southall, attributed the latest change largely to a rapid rise in nominal interest rates, the sharpest three month increase seen in years, which has in turn benefitted schemes that have not fully hedged their interest rate risk.

He also explained that whilst these benefits were partially offset by a rise in expected inflation, growth assets also posted a strong quarter, boosting asset values.

“One notable feature of our EPBM measure is that it cannot exceed 100 per cent," he continued. "As the EPBM figure edges closer to 100 per cent, continued positive experience for schemes has a smaller marginal impact on our measure.

“From a covenant perspective we chose to retain a typical sponsor rating assumption of BB in our calculations as confidence in the recovery improves.

“Whilst the long-term impact of the pandemic remains unclear, fiscal and monetary actions have been extremely supportive. We noted that if a rating of B was assumed, the EPBM figure at 31 March 2021 would be around 1.1 per cent lower.”

Adding to this, LGIM head of rates and inflation strategy, Christopher Jeffrey, stated: “The global reflation trade played out in force during the first quarter. The consensus continued to mark up its 2021 growth outlook on the back of fiscal stimulus and the vaccine roll-out.

"US Treasury yields rose more in Q1 than any quarter since 2016 Q4. There are clear parallels with that episode: a sharp move higher in US sovereign funding costs driven by political transition that dragged up yields everywhere.

“Risk assets remained immune to that reset in discount rates with equity markets supported by a stronger earnings backdrop, and credit markets enjoying abnormally low default rates.

“There are a few hints of inflation concern entering the market narrative with breakeven inflation and commodities moving higher since the turn of the year. The fate of inflation as economies around the world reopen will make or break the market dynamic over the rest of the year."

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