The Covid-19 crisis has caused the funding level of a typical pension scheme to fall by 8.4 per cent in the first quarter of 2020, XPS Pensions Group has revealed.

In its quarterly Investment Bulletin, XPS said that a typical scheme had seen an 8.4 per cent drop in asset value and a 3.2 per cent increase in liabilities.

The firm predicted that, in a worse case scenario, the funding impact on a typical scheme could be a further 26 per cent in the next 6-12 months, driven by a 50 per cent fall in global equities.

It’s ‘central case’ scenario forecast a further 5 per cent drop in the typical scheme’s funding level, while in a best-case scenario, XPS said that scheme funding would recover by 12 per cent.

“Over the first quarter of 2020 we’ve seen the funding level of a typical pension scheme plummet by an unprecedented 8.4 per cent,” commented XPS head of investment, Ben Gold.

“Even though most asset prices have fallen considerably, with so much uncertainty over the impact of Covid-19 on society and the global economy, our outlook on most asset classes is unfavourable.

“Schemes need to understand what could happen from here, and plan for different scenarios that could play out over the next 6-12 months. The results are sobering.”

In response to the market volatility, XPS urged scheme trustees to review investment risk tolerances, especially what their sponsoring employer is willing to support considering the possible deterioration in covenant.

It also recommended reviewing portfolio liquidity and short-term cash flow requirements, checking whether interest rate and inflation hedging has performed “in line with expectations”, and to assess underlying sector and regional exposure.

The bulletin added that trustees should consider holding a greater cash buffer to meet benefit payments, but to avoid using the trustee bank account for this, while those who are implementing a strategy change were urged to consider reassessing if it continues to be suitable.

Gold continued: “The best case is that pension schemes broadly recover the losses seen over the last quarter, but we think this is pretty unlikely in so short a time period.

“Our central case is for a further deterioration in funding levels from here of some 5 per cent. But we think there is a chance that things will get a lot worse than this, with funding levels falling by a further 25 per cent or more.

“This would be devastating for pension schemes and their sponsors at a time when many businesses are struggling to survive. In our view it is vital right now that trustees ensure their schemes are protected against the worse outcomes we could see.”

XPS modelled the typical scheme as a scheme that has an assumed asset allocation of 27 per cent equities, 34 per cent corporate bonds, 11.6 per cent multi-asset, 4.8 per cent property and 22.6 per cent in liability driven investment (LDI) with the LDI overlay providing a 50 per cent hedge on inflation and interest rates.

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