The combined deficit of UK defined benefit (DB) pension schemes against long-term funding targets fell by around £72bn over December 2021 to £309bn, according to XPS Pensions' DB:UK Funding Tracker.

Based on assets of around £1,895bn and liabilities of £2,205bn, the tracker revealed that the average funding level for DB pension schemes on a long-term target basis had increased to 86 per cent as of 31 December, up from 83 per cent in November.

The changes over the past month were attributed to a rise in gilt yields following the Bank of England’s announcement that it would increase base rates from the historic low of 0.10 per cent to 0.25 per cent on 16 December.

The update was highlighted as a “welcome improvement” from the deficit increase seen in November, when the combined deficit of UK DB pension schemes peaked at £400bn amid political uncertainty, high inflation expectations, and the emergence of the Omicron variant.

XPS Pensions Group actuarial consultant, Tom Birkin, identified the resulting rise in gilt yields seen amid the decision to increase interest rates as "welcome news for sponsors of pension schemes after a difficult November".

However, Birkin warned that, with uncertainty over inflation and Omicron persisting, sponsors and trustees should be braced for further volatility in 2022.

Adding to this, XPS senior investment consultant, Felix Currell, suggested that the significant movement in interest rates and inflation has stressed the precision of hedging strategies over the past year.

"This may have introduced some misalignment and we would recommend that trustees review their current hedge exposure to ensure it remains in line with their target," he continued.

Indeed, XPS estimated that, at the end of 2021, the average pension scheme would need an additional £29,000 of funding per member to ensure it can pay their pensions into the long term.

However, it clarified that whilst this may concern members, pension schemes are working hard to reduce deficits, also pointing out that the recent growth in inflation will mean that members whose pensions increase in line with inflation will be better placed than most to handle the predicted higher cost of living in 2022.

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