DB scheme funding levels improve amid rising inflation

UK defined benefit (DB) pension schemes have, on average, remained in surplus over the past month, while the accounting deficit of FTSE 350 companies’ DB pension schemes fell by £24bn in April, according to industry research.

PwC's Pension Trustee Funding Index revealed that asset and liability values for the 5,000-plus UK DB schemes both fell over April 2022, resulting in a "modest" increase in surplus to £130bn based on schemes' own funding measures.

It also pushed the funding ratio for UK DB schemes up from 107 per cent in March to 108 per cent in April 2022.

In addition to this, the surplus according to PwC’s Adjusted Funding Index, which incorporates strategic changes available for most pension schemes, including a move away from low-yielding gilt investments to higher-return, income-generating assets, and a different approach for potential life expectancy changes, increased to £270bn.

Similar trends were also seen in Mercer's Pension Risk Survey, which revealed that the accounting deficit of FTSE 350 companies’ DB pension schemes fell by £24bn in April to £45bn.

The tracker showed that the liabilities for the UK’s 350 largest listed companies' DB schemes declined from £837bn at 31 March 2022 to £784bn at the end of April, amid further increases in corporate bond yields, while asset values fell from £768bn to £739bn at the end of April.

Mercer UK wealth trustee leader, Tess Page, noted that the month-on-month improvement has meant that the month end position is now back at a level last seen in April 2020.

Page suggested that the main driver for this change has been the recent increase in bond yields, highlighting these improvements as good news in the current economic environment.

However, Page noted that The Pensions Regulator (TPR) also recently issued its 2022 Annual Funding Statement, which emphasises TPR’s expectations for strong governance and robust integrated risk management especially in the context of the current economic and geopolitical situation.

“Even schemes that have good arrangements in place need to keep them under review, and it is likely that all schemes, even the best prepared, will need to take some action in view of the current climate," Page added.

Despite this, PwC global head of pensions, Raj Mody, suggested that, with inflation still rising, the surplus trend for UK pension schemes is likely set to continue.

He explained: "Most pension scheme benefits are linked to inflation, but there’s usually a maximum increase that will be paid each year for members. Around nine out of 10 schemes have limits on how much inflation they pass into pension increases.

"For nearly all of these 4,500 schemes, this cap will be lower than the current rate of inflation, and so their liabilities will not be fully exposed. This gives them a buffer on top of existing surpluses.

"Even schemes with a modest deficit might well reach surplus by just waiting. There’ll be a few exceptions, including schemes who have put in place insurance or hedging, when a third party will get the advantage from any inflation cap, instead of the scheme."

Commenting more broadly, however, Mody acknowledged that caps on pension increases do not only have an impact at the scheme level, and will also affect pensioners.

"Pension increases in DB schemes are also typically only granted once a year, with reference to historic levels of inflation. Pensioners may well need to wait another year until their benefits catch up with the current inflation rates we’re seeing today," he continued.

"There’s a lag effect which doesn’t matter in times of stable and low inflation, but can hurt in times of high and unpredictable inflation.”

In addition to the impact of recent rising inflation on DB members, PwC pensions actuary, Laura Treece, also highlighted the impact of the historic levels of inflation on those who receive state pension.

"State pensions went up by 3.1 per cent - less than half of the inflation rate recorded for March of 7 per cent," she explained. "And with inflation predicted to keep rising, the extra money going into pensioners’ pockets won’t cover the amount by which their bills are going up now in line with current inflation."

Treece warned that this is a "tough situation for a lot of people", which has prompted some sponsors and trustees looking to think about how they might help their pensioners.

She continued: "Some are actively considering paying discretionary top-ups to pensions if the high inflation rates we’re seeing continue.

"This is something we haven’t seen much of recently - discretionary increases were more common in the 1990s when there was no compulsory requirement for pension payments to go up each year. We may start to see more and more schemes bringing back this practice if inflation remains high.”

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