DB scheme health: getting better?

Good news is always welcome, so I am delighted to share the latest insights from our quarterly assessment of the health of the country’s DB pension schemes. Encouragingly, they have continued to improve from the sharp decline experienced around the first peak of the pandemic.

We found that the average¹ DB scheme can expect to pay 98.2% of accrued pension benefits, as of 31 March 2021, up 6.8 percentage points from 31 March 2020².

The UK’s DB pension schemes have also shown a 1.1 percentage point improvement quarter on quarter against the funding level of 97.1% at 31 December 2020³, to 98.2% at 31 March 2021, and this latest improvement means our measure has now recorded a continuing improvement in each of the past four quarters.

This change in our Expected Proportion of Benefits Met (EPBM) measure of scheme health was largely driven by a rapid rise in nominal interest rates, the sharpest three-month increase seen in years, benefitting schemes that haven’t fully hedged their interest rate risk.

These benefits were partially offset by a rise in expected inflation (increasing inflation-linked liabilities) but growth assets also posted a strong quarter, boosting asset values. One notable feature of our EPBM measure is that it cannot exceed 100%. As the EPBM figure edges closer to 100%, continued positive experience for schemes has a smaller marginal impact on our measure.

Covenant concerns

From a covenant perspective, we chose to retain a typical sponsor rating assumption of BB in our calculations as confidence in the recovery improves. However, it is important to note that our figures may yet still understate the negative impact of the pandemic, due to a weakening of covenants that many schemes will have endured. We noted that if a rating of B was assumed, the EPBM figure at 31 March 2021 would be around 1.1% lower.

Yet whilst the long-term impact of the pandemic remains unclear, fiscal and monetary actions have been extremely supportive, and we will continue to monitor DB schemes’ health and share our findings with you.

¹ Based on the Purple Book from the Pension Protection Fund, a typical pension scheme holds approximately 20% in equities, 70% in bonds/LDI, 5% in property and 5% in other assets.  For illustration, we assume rates and inflation hedge ratios of 70% of liabilities on a gilts basis (revised upwards from previous assumptions) and no future accrual or deficit contributions.

² As of 31 March 2020, the LGIM DB Health Tracker found that pension schemes could expect to pay 91.4% of accrued pension benefits.

³ As of 31 December 2020, the LGIM DB Health Tracker found that pension schemes could expect to pay 97.1% of accrued pension benefits.