Fall in gilt yields drives DB liabilities up by £100bn

UK defined benefit (DB) pension scheme liabilities increased by around £60bn following the Chancellor’s Autumn Budget, bringing the total increase over October to around £100bn, according to XPS’s DB:UK Funding Tracker.

XPS Pensions warned that plans to curb the level of government borrowing have had the biggest immediate impact on pension schemes, despite focus on the proposed spending.

Following the Budget, the Debt Management Office (DMO) announced plans to reduce sales of gilts over the 2021/22 period by £57.8bn to £194.8bn, which XPS noted was a much bigger drop in supply than was expected by markets.

The consultancy explained that pension schemes are driven to invest in long-term gilt market as a result of increasing regulation and in an effort to match underlying liabilities, with the fall in gilt supply therefore pushing yields down and adversely affecting balance sheets.

The tracker showed that the average funding level of UK pension schemes on a long-term target basis had fallen slightly from 87 per cent in September to 86 per cent as of 29 October 2021, for instance, with assets of £1,912bn and liabilities of £2,231bn.

Scheme deficits against long-term funding targets also increased by £34bn during October.

In addition to this, XPS's tracker estimated that it will currently require 13 years to reach long-term targets under the proposed new rules from The Pensions Regulator (TPR), up from to 10.5 years in September.

Concerns have also been raised over the impact of inflationary struggles, although the provider clarified that the key for investment markets will be in how this translates to long-term inflation, and whether economic growth can be sustained in real terms.

XPS Investment senior consultant, Felix Currell, commented: “Short-term interest rates and inflation are intrinsically linked, however the key focus for pension schemes is on rates at the longer term.

“This announcement from the DMO serves as a reminder that supply and demand factors play as much of a role in longer-term yield movement as economic factors. It is important the trustees understand the unpredictability of the risks carried by their scheme, at a time where many individuals were expecting yields to move in the opposite direction.”

Adding to this, XPS Investment partner, Adam Gillespie, commented: “TPR’s draft funding code encourages trustees to look long-term in setting their strategies, which is what drives our work with XPS’s DB:UK Funding Watch.”

“Whilst hedging strategies are commonplace, there is a wide range in how these are executed and how much protection is offered.

“For example, there are many reasons why trustees may want to consider implementing hedging targets above the level of technical provisions, for example to protect their schemes against the risks faced in reaching their long-term objectives.

“A hedging strategy should form a key part of setting an appropriate journey plan to give trustees a smoother path to their long-term goal such as buy-out or run-off.”

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